Q:

Does the quality of images from a small sensor improve significantly year-to-year?

As I understand it, larger image sensors on digital cameras make for higher quality pictures, but does a given size sensor produce significantly higher quality this year from the same size sensor of 1, 2, or 3 years ago?  Specifically, a 1/2.3 sensor?  And does a higher megapixel count actually make a huge difference on a 1/2.3 sensor form one year to the next? 

A:

It depends on what aspect of the sensor you are looking at.  In terms of obtaining shallow depths of field and rich background blurs, this is a physical limitation rather than a technical limitation and will remain an advantage for larger sensors indefinitely.  Similarly, the aperture at which diffraction limiting is reached is better on a larger sensor for a given resolution.
For technical characteristics such as noise level and low light performance however, this does eventually change.  As sensors are produced with lower noise floors, the sensitivity of a smaller sensor can grow to overcome the smaller photosites required on a smaller sensor of the same resolution.  Additionally, as photosites are able to be made smaller, higher resolution can be accomplished on a smaller sensor than previously would have been possible.

A:

Most improvements in camera image quality fall into two basic categories: either sensitivity of the photosites on the sensor chip or improvements in the processing of the signal after it has been read out.
Improvements in signal processing tend to be more incremental and each model evolution will usually include minor improvements in signal processing. If a camera allows you to save files as RAW images then some later developments can be applied to older images with newer RAW conversion software. If a camera only saves images as JPEGs, then an update to the camera's firmware is the place where the majority of improvements in processing could be applied. In practice this rarely happens for cameras with 1/2.3" chips as the manufacturers of the consumer grade, small sensor, JPEG only cameras would rather devote resources to promoting and marketing the "new and improved" replacement than to extending the capabilities of a model no longer sold.
Improvements in the actual efficiency of sensor photosites tend to be more quantum in nature. Rather than refining an existing design, major improvements are a result of a new design that performs better in terms of how much of the light that falls on the surface of a sensor is converted to usable signal. Things such as backlit sensors, gapless pixel wells, or non-Bayer pattern color masks are the type of developments that result in significant sensor performance improvement. Within any one particular brand the same basic sensor technology can stay fairly level for several years before an improved design comes along.

