My daughter (8) got one for Christmas last year and my son (7) will be getting one this year. For the record, they don't own Ds's, cameras, etc.
Some things my daughter uses it for:
1.Emails her grandma and a few other friends/relatives. I love that she has an independent relationship with my mother. They send pictures back and forth, update each other, etc.
2.PingChats (msn type messaging) me and her other friends who have iPods
3.Checks the weather every day to determine what to wear. She shares this information to me which I find quite useful.
4.Plays lots of games (of course). Most were free, I think I bought her a couple of .99 games which looked interesting. She plays games with me (Chess With Friends, Words With Friends) which I think is pretty cool.
5.Looks up words or information she doesn't understand or wants to know more about.
6.We have a Countries of the World App which she finds fascinating - she is especially interested in flags
7.Listens to music. We share an iTunes account, so for the most part she gets music we're buying anyway, so no cost to us
She has the older iPod without a camera, so she doesn't use it for pictures, etc. which is too bad.
There are other things she does with it, but these are the things I notice her using it for the most. It's not just a toy, it's a useful tool. She's very careful with it (my biggest fear was a cracked screen).