Open the AVD Manager.
Click Edit Icon to edit the AVD.
Click Show Advanced settings.
Change the Internal Storage, Ram, SD Card size as necessary. Click Finish.
Confirm the popup by clicking yes.
Wipe Data on the AVD and confirm the popup by clicking yes.
Important: After increasing the size, if it doesn't automatically ask you to wipe data, you have to do it manually by opening the AVD's pull-down menu and choosing Wipe Data.
Now start and use your Emulator with increased storage.