This question requires an inference to determine the importance of the dinner as a prize. There are some possible inferences:

1. The group is going to make a pilgrimage of over 70 miles to the Thomas A Becket site and back. Food was an essential element in the early middle ages, and it was basically what people lived for because it was the source of energy they needed to carry on with their lives. Think about it: Compared to this century, food was not a pleasure, but a requirement as essential as water, air, and shelter. 

This was also the feudal age in which "eating out" was certainly a luxury that many peasants (especially those in the party) could not afford. Even the rich at the time were experiencing a moment in history where the hierarchy was transitioning from the rich, pedigree-based families to families who had pedigree but no money. It would have been a treat to them as well.

2. The second inference is the fact that the group met at the Tabard Inn in London whose owner told them lots of happy and funny stories. Hence, he offered them the best he could give based on the above-mentioned circumstances: A free dinner.

Why does the Host in the Prologue to The Canterbury Tales suggest a prize for the pilgrims at the end if they win the challenge?

I assume that the host does that because he wants the best chance of having a bunch of really good stories.

The way I see it, the host was going to be hanging out with these people for quite a long time on the way to Canterbury for the pilgrimage and on the way back.  Imagine how boring that would have been back in the days of now portable DVD players or iPods or anything.

So the host wants to be entertained.  I think he figures that he'll get better stories and be more entertained if he offers a prize.