The "images" directory inside your powergallery is a reserved directory that the installer will create on the fly to save all images for powergallery. So, the first step is you should rename that directory to something else that won't conflict.
I would probably just start the install over (clear out the powergallery directory completely and re-upload the files from the zip) to make sure it sets everything up as its needed. When you get to step 5 (or the server upload in the admin), it will default to a directory. Rather than typing in a path, you can just click the folder icon and it will allow you to browse around. In the case of the installer, the default directory will be powergallery/install/samples/. You could simply click the up arrow 2 times then you should see your renamed images directory. Click on that and it should list any images it contains. Then the images will process correctly. The path is a filesystem path not a web path with the http part.