Vista : under C:\Users\[your login Windows login name]\AppData\Roaming\Skype\[your Skype login name]

XP: c:\documents and settings\\Application Data\Skype\[skype username] directory

1 - Open config.xml for editing (right click the file and choose edit).

2 - Find <video> section. Add these lines

<CaptureHeight>480</CaptureHeight>
<CaptureWidth>640</CaptureWidth>

and after adding my <video> section in config.xml, it looks as follows:

<Video>
<AdvertPolicy>contacts</AdvertPolicy>
<AutoSend>1</AutoSend>
<CaptureHeight>480</CaptureHeight>
<CaptureWidth>640</CaptureWidth>
<Device>Logitech QuickCam Ultra Vision</Device>
<Disable>0</Disable>
<RecvPolicy>contacts</RecvPolicy>
</Video>

*You of course need to replace the device name in the setting with your own device name. You can see the device information if you run "dxdiag" and then save its output as text file (see above for example).

3 - Some information I found using Google suggested to also add to the <video> section <Fps>25</Fps>. But that only confused my version of Skype and gave me low quality video. You can try, but I suggest to not add it.

4 - Save config.xml file and open Skype again. Try video chat and hopefully enjoy the better resolution!