"If you believe that FFVII was the reason why the PS1 succeded, do you also think that FFXIII is going to turn around the fortunes this generation?"
No way. It a totally different set of circumstances.
I really think that Nintendo droped the ball with the N64. It should of been a CD based system. But thanks to the their venture with the CD-I, Nintendo had cold feet with the CD technology and stuck with cartridge. Square created the tech-demo on some SGI machines gearing it toward the N64. What they found out was that they could not do what they wanted with the N64 because of it's cartridge size constrants. Could you imagine if the entire Square library from PS1 was on the N64. I'm sorry, but that would have been huge.
The same could be said toward other developers. Producing a cartridge game costs more and limited what you could do.
You said "It didn't matter that the majority of the games were bad as long as there were enough good games. The same was true for the PS2 and the same will be true for the Wii. A console is only in trouble when there aren't enough good games."
Well, the PS1 and the PS2 had excellent 3rd party support. The Wii does not. All you have to do is just look at the scores. Will the Wii get better 3rd party support? Mabey, but as of right now there aren't any 3rd party games that look up to that task. I would say the Wii might be in trouble if the market is flooded with shit games. Beyond the always good Nintendo games, does a casual gamer know which game is good and which game is bad.
The only problems that cartridges faced for games was the limited space and that only prevented developers from using huge amounts of FMVs and CD music. These are things that aren't important for good games. The disadvantage of CDs were long loading times compared to none for cartridges. If you look back at PS1 and N64 games now, the N64 games aged much better than the PS1 games.
The cost of cartridges was a problem for developers, but as I said above the only limits for games were lack of space for huge amounts of FMVs and CD music. Game length wasn't influenced, graphics obviously weren't either, because the N64 was more powerful than the PS1.
But the point that "the change of the business model was by far the most important reason why Sony won the 5th generation" still stands. I don't think we have to discuss CDs vs. cartridges any longer, because it's going off topic (not that our whole debate was on topic anyway), the original point of the discussion was "what was the most important reason why Nintendo lost to Sony".
The library of a console isn't restricted to only 3rd party games. That you have to base your argument solely on 3rd party games just shows that your point is weak. Casual gamers obviously don't know that much about what is a good game and what is a bad game, just look at the million seller list of the PS2. But the PS2 is still accepted to be one of the best systems in videogame history, so I don't see how the Wii would be in trouble.