My family is very, very fortunate! We live in a 1200 sq ft house we built 3 years ago - 2 bedrooms and a full bath up, greatroom, den, pantry, half bath, laundry closet down. No basement. Right now it's actually too big for the 4 of us - we cosleep and the boys play in the greatroom, so their bedroom is rarely used, and we rarely use the half bath. We have closets in each bedroom to help with seasonal storage.
I purge A LOT and often, so we have no clutter and no space use issues. Also our philosophy is buy better quality, but less, so we have a small amount of very open ended toys for the boys, pretty enough to display housewares, that kind of thing. No knick knacks or purely decorative items. Very basic furniture, solid color fabrics...we're just about to the point where there really is nothing left for me to give away, and thankfully our friends and family either have the same philosophy or are at least respectful of ours, so no one gifts us uneeded items anymore.
I love having a small house and wish it was smaller! I like the tiny mortgage, not having a lot of stuff, not having to spend lots of time cleaning, and especially because the way our home is designed, we spend most of our waking hours together as a family. We have high ceilings downstairs, lots of windows throughout for natural light all day long, and the most used material is wood - since we weren't paying for square footage we could put funds towards niceties like big windows, hardwoods floors, butcher block counter tops, and a wonderful deep soaking tub. So it is really very pretty and comfortable.
Most other people love our house too. They are always surprised when they enter at how much bigger it feels on the inside than it looks on the outside. We never have issues entertaining, although overnight guests will be hard when they boys start sleeping in their own room.