On the other hand, doesn't that mean it probably doesn't have any dedicated graphics memory, just general 256MB of RAM
I'm not sure how much RAM the iPhone 3G(S) has, but you're most likely right it has no dedicated VRAM. Then again, it doesn't really need it, since as already mentioned, its GPU is a tile-based deferred renderer, so its bandwidth requirements are quite low, and the iPhone's screen resolution is very low also. A full-screen framebuffer is tiny, so there's no need to be concerned here.
The PSP's EDRAM is 4MB of dedicated video memory and combined with the two VMX capable media processors it can do some pretty nifty stuff.
Only those 4MB are on-die with the PSP, the main RAM is off-chip. And that's...what? 16MB? 32? As for the two media processors you mentioned, AFAIK I know of only one media processor (the other's the vector maths co-processor to the CPU), and at least early on in the PSP's lifespan that media processor was not opened up to the developer.
Anyway, iPhone has a 600MHz CPU that's generations more recent than what's in the PSP, along with advanced floating-point vector extensions and other modern stuff. It's just way faster really.
Like I said, the only real reason the PSP's games look better than the crap available for the iPhone is the target audience. Nobody's actually even TRYING to do high-end stuff on the iPhone; there's no market for it, you would just lose money.
Other than when it comes to interaction with the device itself (buttons, joystick etc), iPhone has the clear advantage from a hardware point of view. A touchscreen simply can't beat a proper D-pad, shoulder triggers and front face buttons other than for certain casual gesture-based games.
A proper PSP 2 (instead of that half-baked PSP Go) with proper buttons and iPhone-like hardware innards would just blow the old PSP out of the water. It wouldn't budge the iPhone crowd though, since they want an iPhone, not a games machine.