Interesting, I had never enabled that and for me it works as expected. Do you have any other addons installed that mess with downloads, or did you make any about:config
changes in regards to downloads?
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I have a blank copy of Firefox that I just open, I also have the option to always ask turned off there and it asks for the download location when trying to download images.
Are you talking about downloading files or about right clicking on images and pressing "Save Image As..."?
The later.
I think it still asks if the default download location is inaccessible, so check that maybe?
I don't think so, its just the downloads folder on my Mac.