does it mean that the person who used the flag on that post somehow gets to decide who the reward goes to?

No. It's returned to the pool and distributed to everyone else based on the votes they received. All upvotes count a little bit more.

how big a group is this circle

Huge. Everyone got used to the system being broken, and it will take a long time to change the culture, if it's possible at all.

Can't predict how communities will work out, we will see.