- A micro instance should work, although you'll only have 600 MB of memory. Also, I hear that micro instances have poor cpu scheduling, which would make your apps to feel jerky and sometimes freeze for 1-2 seconds. If you try it please let me know how it works.

- FreeNX provides a graphical interface. It makes your Linux program windows appear on your Windows machine.

Yes, the Linux Micro instance should be enough to run a development environment. And yes, you can have a graphic interface, but I'm not sure it's your best option (both for bw. And memory usage if you're in the micro instance might be a little bit to high.