A big graphical leap forward for PS4/720 would mean losses by the hardware manufacturer. While I'm sure Sony is up for that again, I doubt Microsoft is. I think Microsoft has reached a complacent level with 360 and I doubt they'll go all out for their next console unless they are really, really stupid and want to throw those big profits away.
I don't think so. PC games today on the top settings look a good deal better than PS3/360 games, and that will continue to advance by the time the 720/PS4 are out (I don't see them coming out before late 2013 at the earliest, and 2013 or 2014 probably more likely).
It wouldn't take a super pricey console to make that kind of graphics leap.
In any case, taking a nice step forward in graphics will be key. Cutting edge graphics are huge in selling consoles to the core market. People are going to get whatever console Call of Duty, Madden etc. look the best on among the Nintendo, Sony and MS offering.
If only one of them goes with a big leap forward, then that's who'll win the console sales war next generation. So I'd be shocked if only Sony took a loss and put out a very powerful console as MS would be giving away the market share lead the won this generation. Most of the money is made selling software and accessories, so they can afford to take some losses the first few years on hardware.
And in general, a big step forward is really necessary to get people to buy. Who's going to want to shell out money for a new console if games look mostly the same as on their current consoles? That was a big part of why the Wii didn't appeal to core gamers--they weren't into motion controls and casual games, so why buy a console with games that looked pretty much the same as Gamecube games? Graphics advances are a big part of selling a new console to the core, so I don't think we'll see a PS4/Xbox 720 until they can make a nice leap forward and do so without taking too much of a loss per unit--hence why I think 2013-2014 is a likely launch frame.
In any case, all this discussion about the core and Nintendo is really moot. There's just not much of anything Nintendo can do to get the "core" back as the core views Nintendo as for kids and soccer moms so they're never going to buy a Nintendo console and play Call of Duty, Madden etc. on there instead of the PS/Xbox.
The best Nintendo can do is do a better job with their franchises and new IPs and get more gamers to pick up a Wii U as a 2nd console and hopefully thus get their software attach rate up next gen. If the Wii U software lineup isn't any better than the Wii's, next generation will be the first generation since I started gaming seriously (NES) that I don't own a Nintendo console.
What about software developers? Can a big leap in power in the next gen systems go too high before it becomes overly costly for game studios? On one side I would think better graphics will lead to higher costs, but then they wouldn't have to focus on working around hardware limitations. Clearly I don't know much about the development process, but I do know making games is already getting more expensive.
I think the move to HD was the main thing that drove costs up. As well as needing to hire voice actors and all that kind of stuff.
So I wouldn't expect to see development costs go up with another leap in graphics as it would just be having better textures, draw distances etc. from having more power to work with.
Maybe if more games are coming out in 3D that may drive costs up some I suppose. But other than that, I wouldn't expect to see another big leap in development costs until there's new display technology out.