This week I am in Cape Cod with my wife's family, including our two toddler nieces.  They have enjoyed playing with my iPad (supervised of course) and I have enjoyed seeing which apps they like interacting with the most.  Here are two they have liked so far:

iWriteWords (Free)
I wrote about this app that I learned about from Seth Bowers.  My 2 1/2 year old niece really enjoyed tracing and identifying the letters.  The only part she needed help (i.e. she didn't understand it) with was tilting the iPad so that the letter blocks fall into the "vortex."

3D Drum Kit for iPad ($2.99)
I got a couple of iTunes gift cards for my birthday, so I have been purchasing more apps than I normally might.  The ones that I have been most interested in are the musical instrument and production applications.  Both my 2 1/ year old and 20 month old nieces have liked smashing this drum kit.  It has an easy to use recording interface and a couple of different drum kit sounds.  The drum kit is animated, unlike other drum kit or drum pad apps that just play the sounds.