But if you look at CS4 by Adobe, it comes out to $2500. You have to identify the marginal returns in each, and then be able to make some sense out if it. (Also take into consideration law of diminishing returns) Another thing, you say it wasn't good business sense, yet Sony released the PS3 losing about $250 per console when it was released. They saw that even though it was not cost effective, the Long Term Opportunity Cost was actually quite the opposite.
I think the reason for the software update is that perhaps consumers are sick and tired of buying proprietary MS crap. I myself am included in this group. Wireless for $99 on the 360, or Ethernet cable for ~$7. Consumers will be consumers, and nothing will change that. Hardware or software, there will always be those consumers who need to have the newest gadgets. Nothing can change this.
Incorrect. It is not cheaper to develop software rather than hardware. Each one has it's own market and neither can be compared to the other. It is incorrect to say that producing hardware will be more expensive because the demand for hardware is completely different than the demand for software. For example, it is possible to purchase a higher end graphic card for ~$500, or a complete laptop for the same price.