Vmware memory issue or windows 2008 memory issue...

Are you using a 64 bit version of Windows 2008, because the limit of 32 bit Windows is 4GB?

Most likely Physical Address Extension needs enabled:

http://social.technet.microsoft.com/Forums/en-US/winserversetup/thread/ece2d9a9-26bf-488a-a7d3-174ed0937eab/

Also check the memory limits for Windows Releases

Windows 2008

http://msdn.microsoft.com/en-us/library/aa366778%28v=vs.85%29.aspx

System Support for PAE
http://msdn.microsoft.com/en-us/library/aa366796%28v=vs.85%29.aspx

PAE is supported only on the following 32-bit versions of Windows running on x86-based systems:

    Windows 7 (32 bit only)
    Windows Server 2008 (32-bit only)
    Windows Vista (32-bit only)
    Windows Server 2003 (32-bit only)
    Windows XP (32-bit only)
    Windows 2000 Datacenter Server
    Windows 2000 Advanced Server

Do you need 16GB of memory for the Server?

Windows 2008 supports automatically enables PAE if DEP is enabled on a computer that supports hardware-enabled DEP.

Do you mean that the My Computer Properties shows 16GB?

The issue you are querying is Task Manager only shows 3GB?

Okay, I've checked and re-checked this memory issues.

Windows Server 2008 Standard 32 bit memory limit is 4GB. (even with PAE enabled)

Only Windows Server 2008 Enterprise 32 bit memory limits is 64GB with PAE enabled.

PAE is enabled automatically on DEP aware hardware (which VMware is!).

Select a 64 bit version of Windows 2008 Standard, or Windows 2008 R2.

windows 32 bit machine supports RAM upto 3.5 GB. x64 windows will support you configuration.

if this system is x64 architecture then you can enable intel visualization mode and enable it in bios and then install windows 2008 x64.

-prakash