Dr. Raymond Soneira from DisplayMate did some testing on the displays from the Google Nexus One, iPhone and Motorola Droid. Apparently, the cause of the reports of inferior image quality reported previously (especially on the Nexus One are due to how the color is displayed.

While using the Gallery in 2.0.1, he noticed that the application used 24-bit color, but after an update to 2.1, Gallery only used 16-bit color.

DisplayMate's report said this:

Presumably these errors, which affect both the Droid and the Nexus One will be fixed in a future software upgrade, so the Droid will at some point return to its original excellent 24-bit color and scaling. The quality of the 24-bit color and scaling for the Nexus One remains to be seen...

According to TalkAndroid, Google released a statement saying that they developed the Gallery app in 2.0.1 with 24-bit color, but that Cooliris developed the Gallery app for Android 2.1 with 16-bit color.

Other Sources: AndroidCentral, Androinica, Gearlog, TalkAndroid

Image from Gearlog