The first step is go to Setting in Google Reader, then click on the Send To link at the top of the window.

Click on the “Create a custom link” button, and enter “Instapaper” (or whatever you want) in the Name field.

In the URL field, enter the following URL:
https://www.instapaper.com/api/add?username=[EMAIL]&password=[PASS]&url=${url}&title=${title}

Just replace [EMAIL] with the email address you use to log in to Instapaper, and [PASS] with the password you use.
If you don’t use a password with Instapaper, just omit the “&password=[PASS]” part from the link.

Haven’t figured out the icon URL part yet, so leave blank for now.

Now click on Save, and you’re done.

Now, on each item in Google Reader, when you click on the Send to link under the item, Instapaper should be one of the choices.

Let me know how this works for you.