Folks that want/need more control over the environment, ability to manually manage their own machine instances, run code other than python, etc. will stay with EC2. EC2 is a step above RackSpace.
But rather than thinking of AppEngine as a step above EC2, instead I think of it somewhere around Myspace. Or "Ning 1.0", as Zoho points out.
In the beginning was GeoCities... No, even further back, in the beginning was Hypercard. Hypercard was a pre-web application for Macs that let you design a "stack" of pages - a website on a floppy, really. Popular stacks got traded far and wide. Hypercard stacks existed for every imaginable purpose - "Time Table of History", games, crossword puzzles, the Bible, etc.
The thing about Hypercard was that it wasn't just static text and images like base html. It had a scripting language, a database, and the Apple UI built-in, so you could create mini applications.
It feels like the web has been trying to claw its way back to the simple utility of Hypercard ever since Mosaic. GeoCities was the first massive-uptake anyone-can-build-here website haven. But it was all static html.
So to hide all those details behind a platform that's easy to get started with, and lower the bar to entry to writing public application websites... Well that's a big deal. Hat's off to Google for bringing this to market.
I'm not alone...somewhat similar thoughts from Nate Westheimer...