Here is a few points that should temper how far the next-gen graphics can increase:

1. Casual gamers don't care that much about graphics, gamelplay and fun is far more important as evidenced by the success of Wii and more recently Kinect.

2. Sony and M$ cannot keep releasing consoles for a loss.  We are now in a down economy and investors are looking for immediate returns as opposed to big risks.  It is currently rumored (and semi-confirmed by a Sony executive) that the NGP will sell for a profit not a loss.

3.  Sony and M$ cannot sell for a big loss, but they also cannot increase the price that far beyond $300.  $350-400 is probably the absolute price ceiling for the next-gen console prices.  Sony and M$ will basically have to rely on a longer console life cycle if they hope to replicate the same leap in graphics as shown from PS2 to PS3.

4.  Heat problems are always going to be a big problem.  One of the biggest problems with shrinking all this processing power into a small area is that heat and ventillation problems become harder to deal with.  The 360 already had huge problems with overheating, and the PS3 has had this problem to a lesser extent with the YLOD.  If you read any article about Moore's law and future microchip development heat is listed as one of the serious challenges to the progress of Moore's law.  More microprocessing power means that more power consumption is required which means that more heat is produced as a by-product...

5.  Development costs have already shot out the roof.  Many big budget games are costing over $50 million to make, and some games such as Red Dead Redemption have been rumored to cost as much as $100 million. Who is going to pay for all this progress in graphics?  Consumers don't want higher priced video games. So how are developers going to suddenly figure out a cheaper way to create games?  Nintendo recently stated that they haven't found some sort of magic formula to decrease the cost needed to make a high quality game.  If video games like LA Noire begin to look like movies then their budgets will also begin to approach movie-like proportions.  If you know of emerging technologies that decrease development costs I would be interested to hear them.

6.  The average gamer won't notice or be inclined to buy a new console just because it uses 1080P resolution with 60FPS.  Some hardcore gamers will be impressed by this, but what is going to be the draw for the average gamer? 

7.  Innovations like internet streaming, Onlive, and Apple TV will continue to erode the need to continually upgrade to better hardware.  Cloud-based gaming will become very real once the United States can increase bandwith and broadband capacity.  At this point, the traditional gaming power structure will be totally altered.  Monthly services and cheap 'apps' will start becoming more common place in the next-gen.

You make great points. People still think 1080p at a solid 60 frame rate will be the new generationyet this is something to suit the hardcore not the average consumer.

-If you want next-gen console just add to this current gen 4 to 6 gb of ram and an up to date GPU ..

those are the 2 main parts that really needs to be upgraded/replaced and still keep the low cost of the systems

The Xenon and Cell processors are gassping for memory and with little back up from their GPU.

is like a fish on shallow waters gassping for air than having a turtle trying to push him back in..