I achieved what was promised - short URL's, for most pages.
However, there are pages that generate URL's to other pages that do not respect this setup.
For example, after setting it all up, I tried to uplaod a sample picture and then delete it.
"Delete" link on that page is generated to use NOT pretty version of the url, ie: /w/index.php?action-delete&...
Same for many other links that are action "buttons": Go button on running queires on secial pages, link to view current user account - all have non-magled, un-pretty url in them;
My guess, php code behind those pages does not use $wgArticlePath variable, but instead uses raw $wgScriptPath, which causes them to generate links against this setup;
Also, upload page actions do not fall under posted rewrite rules. uploaded images were not always showing up. Had to add another rule to rewrite prefix of urls generated with $wgUploadDirectory