I think a lot of it comes down to perception, and I think Geometry Wars is much to blame here.
Geometry Wars was basically a brand new game released on the system for $5. Most XBLA early users, this was a very early game, and this was the face of XBLA. A game that couldn't have existed as a game on the shelf, but for $5, it was well worth it.
Most people view XBLA as an impulse buy, and would buy more.
What I believe skews the numbers are the bigger arcade games. Games like Worms, Alien Hominid, Puzzle Quest, were all worth $10 (or $15). So, these games sell. But, many others would be impulse buys at $5, at $10, you can go to Gamestop and buy a lot of full fledged games used. I think there is something with the $10 mark that makes a consumer step back and think. To use another example, you'll buy a snickers bar for $1, without much thought. But, say they made a bigger snickers bar for $5. Sure, you might pay for McDonalds/Taco Bell/Pizza, and pay $5. But, it doesn't mean you'll pay that for a candy bar, even if it's beefier, and it's "worth it".
Same thing here. Gamers want $5 games, and I think they would buy more. I'd love to sit in a Microsoft meeting and try to devise a strategy to test this.
One other thought though, I don't think the $7 price tag would work. It's ingrained in the heads of gamers here that they want $5 games. I think the $7 might be seen as closer to $10 than to $5.