Problems with Wireless Internet Access

Well.... since you said any help would appreciated, I'll weigh in on your easier questions at the end :)

Is it possible for modems and routers to somehow deteriorate?
      Yes.  Absolutely.  I do a lot of work for non-profits and small schools.  They are small enough they buy a lot of retail consumer networking electronics.  There is a baby-switch, as they like to call it (me too really) that is by Linksys.  I have seen at least 4 of these switches, after years of use, begin to wear out.  Some of us, myself included, can sometimes get into the habit of thinking that it will either work, or it wont.  Its not true.  It can malfunction for months or years without being fully and completely dead.  In the case of these baby-switches, which are 5 port; would work fine, until you plugged something into port 4.  Plug something into port 4, and you needed to unplug the power cable, and restart / reset with no cable in slot 4.  It worked like that for about 3 months before, in addition to port 4, port 3 would have the same reaction.  They finally replaced it.

Are there ways to boost the wireless signal?
    Yes.  There are.  You could get a signal repeater, most commonly a WAP (Wireless Access Point).  OR... you can stronger antenna for the wireless router.  Here are links to both:  (just as examples, may not work with your equipment, but without model number, cant look up exactly what you'd need)
http://www.amazon.com/Eforcity-Booster-Antenna-Linksys-2400-2483/dp/B000FEDRN8
http://www.amazon.com/D-Link-DWL-7100AP-Wireless-802-11a-108Mbps/dp/B0001CLYDO/ref=sr_1_1?ie=UTF8&s=electronics&qid=1243817523&sr=1-1

Is there such a thing as a congestion factor?
    Yes.  There is.  The great thing about Routers, is that they give the active users all the available bandwidth.  As opposed to what came first, Hubs, which merely divided the total speed by the total ports.  Routers divide total bandwidth by the total computers accessing the internet or home network.  Since there is a finite speed, yes, you can experience congestion.  IF you are both browsing the internet, you probably wont notice.  But if three people are downloading movies at the same time, yeah, you're gonna notice some congestion.  You could also experience congestion from the other side, if you go to a site that is just getting overloaded at a particular time.

As to your particular problem....  the easiest, fastest, cheapest route I can think of, to try and solve your problem, would be to replace the router.  IF you can get a hold of the same model that you have, switch it out, see if it solves the problem, you'll know its a hardware issue. (Especially since you've upgraded and reset the firmware).  The problem is similar to a few things I've seen, and replacing the switch or router was the solution.  
Let me know if you have any other questions.
Good Luck with it.