I've occasionally fantasized about living in a very small house, but never in a high density area. As you suggest, the space you need expands beyond your living quarters. Over the years as my living space has gradually expanded, so has my collection of things. We consume to fit our space. I don't feel that I need more, and should my means significantly increase, I hope my space doesn't. It's not a real need. I wonder if these people acclimate perfectly to these 100sqft spaces, or if like caged animals, it stresses them.
I think they often have little choice. Living space is hard to come by and they often have no choice but to live there. It's a different kind of poverty, the one that not only limits your wallet but also your living space. I think a lot of people just live with it - what else can they do. As a student I often come across dorm rooms of friends no larger than those, but at least those are temporary, with more space on the horizon. I can't fathom living in such small spaces for decades.