As an extension developer should you go with package size limiting and if yes what limit should you use to maintain better UX in terms of the installation process?
Most of the servers have default upload limit of 2MB. It will be easier for your users if your package is less than 2MB in size.
However, this is a minor thing when comes to the installation process. You can instruct your users to increase the upload limit. Or you can provide direct link to the package and users can install it with Install from URL option.