They could have made the 40GB PS3 backwards compatible if they wanted to. It honestly would not have cost them that much.  They had the software emulation ready to go. My theory is that the guys in charge realized that they're still making a nice chunk of change from PS2 sales, and it would be retarded to eliminate that market completely. If more PS3s get sold with BC, less PS2s will be sold. Pretty simple. That would be a bad financial move on Sony's part, especially considering that they're selling more PS2s some places than they are PS3s. They'll still be selling PS2 3 years from now, it's free money.

 .... i think you dont understand that they removed the GS and ram, thats the PS2's GPU btw, from the PS3.The GS is a very screwed up GPU as it didnt boost any form of power (ie flops). Honestly I forget exactly wtf it really did but all i know is Sony might be working on emulating it but truly it wont be a cake walk like emulating the SP1 was. Removing both the ram and GPU manufacturing costs for the 40GB PS3 and the PS2 as they have more GPUs and ram laying around that arent going into some PS3s anymore. 

Yes its good that they are enabling themselves to sell more PS2's but for families not wanting both a PS3 and PS2 connected to the same TV they can still get the 80GB model.  

BC on PS3 would not affect PS2 sales at all since those who are now buying PS2s do not want to pay $400+ for a console.

The only reason they done it was so it would discourage those who buy a PS3 to go out and buy PS2 games instead of new PS3 games. They are expected to drop the price of the PS2 to $99 next year further illustrating they are intending to keep the PS2 alive for a few more years.

 the PS2 price cut should actually be before Christmas 2007 but I wouldnt put it against Sony for wanting to earn some more cash. 

1 - its not needed
2 - it saves some money, lets say $10 a console is 10 milllion per 1 mill PS3s.

Why pay 400/500 to play old games ? why buy new hardware if you want to play old games.

40gb is for those that want to play PS3 games but the price was out of their reach. For the more hardcore theres the 80gb if they must have bc.

I don't know why this keeps comiing up. B/C will be back on the 40GB modles when BB penitration is high enoughf. Sony will start to sell their PS2 library over PSN and it will make them Billions more. Taking out B/C right now will make it a bigger deal when they start that service. Anyone that has been watching this industry over the last 15 years knows Sony is not about what moves will help them last month Sony thinks about what will help them 3 to 5 years from now. In fact they do this in everyone of their divisions. That is why Sony has been the best hardware company of high end electronics for over 50 years.

@ KBG29 : Well Said
The direct answer to the question is this: To get a $400 sku out to the consumer

 I agree completely that they plan to bring it back, but I don't think that changes the current impact of consumer perception.  The idea of course is that any losses now are going to be more than compensated for later, but its still a real issue for consumers right now.  

Actually I have held off on the 60GB despite it being the only level of BC I would be happy with because I am confident they will bring it back in '08 or '09 and I will get a better price, not only for the console but the games by then as well.

This topic is dead, who cares now, everyone is over bc not being in the forty gig. If you want your b/c, buy the eighty gig but don't keep on bringing the same topic up over and over again... :)

Sony cut backwards compatibility because it was the only valueable feature that they could remove in order to upsale someone on the hardware. Eliminating Blu-Ray movie playback wouldn't work because more people have bought a PS2 than all HD-Movie players combined this year; removing wifi wouldn't work because most gamers still don't play games online, and those that do would (probably) be willing to hook it up using a cable or buying an adapter; and taking the card-readers out would be ineffective because almost no one uses them anyways.

Basically, it is very likely that the difference in price to manufacture the 80GB PS3 and 40GB PS3 is very small (maybe $20) but the price difference they're selling them for is much larger; this means that, in order to lose less money, Sony wants everyone to buy the 80GB model.

Personally, I think it was a foolish choice but we will see how foolish it was after holiday sales are done ...