You just need to pull the Labels via get_post_type_object();
<?php
$args=array(
'public' => true,
'_builtin' => false
);
$output="names";
$operator="and";
$post_types=get_post_types($args,$output,$operator);
?>
<select id="" name="">
<?php foreach ($post_types as $post_type ) {
$label_obj = get_post_type_object($post_type);
$labels = $label_obj->labels->name;
?>
<option <?php selected( $instance['posttype'], $post_type ); ?> value="<?php echo $post_type; ?>"><?php echo $labels; ?></option>
<?php } ?>
</select>
Read more here: http://codex.wordpress.org/Function_Reference/get_post_type_object