I disagree on many points. Its all based on individual needs and lifestyles. To me as a college student, the iPad is more of a productivity tool than a gaming device in my opinion. It kind of puzzles me why people pay $500 just to play angry birds and other casual games, watching youtube videos, and other light uses; but again, its their money and their intentions to use it for whatever they like; if people choose to buy it as a cutting board I wouldn't care. And also, I personally used my ipad 3 for taking pictures during my vacations.
The reason for people upgrading is the same. I've owned an iPad 1, 3, and mini and every time I had my reasons for upgrading. My dad lives in south america, and we video chat often. I thought to myself it would be great to be able to video chat from my ipad, but the ipad 1 didnt have a camera. And like you said, I wasnt just going to go out and buy an ipad 2 because they have a slightly faster processor and cameras, so I waited. The ipad 3 came out with better cameras, an even faster processor, and the beautiful retina display. This was enough for me to upgrade. The iPad 4 was released, but it seemed like more of the same; faster CPU, new dock, but nothing really worth upgrading for. The mini on the other hand was a different story. Contemplating giving up the retina display for size and weight of a new, more portable iPad was tough. But going to my local apple store and holding it, I knew it was a step back in terms of its guts, but two steps forward in terms of using in for college. And to be honest, the real appeal for me in the ipad mini was the design. The shorter width of the bezel was definitely attracting me. And to be honest, I may consider getting the ipad mini 2 just to get that retina display back.
So everyone has their reasons to upgrade. And when you say "... I really don't see why people buy a new iPad each time a new version comes out," do you know anyone who does that? Most of the people around here tend to skip a generation before getting a new one, making the upgrades more significant.