This also completely ignores the viral nature of these types of services; people are more likely to use Instagram when their friends are using it. Without being free, it's not clear whether it would have taken off enough to gain 2 million users (or whether it could keep 2 million after the remaining 98 million left).
That said, I'm all for paying for services, and much prefer that model to ads. But just because some of us would prefer that doesn't mean it would have been the right choice for Instagram. It's easy to look back and say "they should have charged users," but we can't be sure we'd be in a place to analyze them if they had.
Use the free stuff to get people hooked, then let people decide how to pay for their habit. If you can make $25/year off of me through my private info, let me decide if I want to pay $25/year for your service (which is, quite literally, pocket change). As it is, I'll just stop using your service (like I'm going to stop using Instagram).