MS could go for some highly efficient 1-1.5TF new technology GPU that performs more like a 2TF current GPU, but this still gives Sony the chance to go with an off the shelf 8850, which even if further cut down and downclocked would still trounce MS's offering. The trade off could indeed be in RAM capacity, which as discussed months ago may not be worth it.
Sony will likely have the same desire to chase the casual crowd with expensive next gen motion controls, but if MS do go a bit too conservative they could capitalise on it without blowing their budget like last time. An 4-8 core jaguar + 8850 would be smaller than CELL + RSX by a long shot, it would also use less power (cheaper cooling and mainboard) and probably cost around half for the chip(s) itself. Don't include legacy processors for BW capability, Blu-ray drives are $100 cheaper now, everything else like HDD would be the same and adding 32-64GB flash wouldn't cost a lot. You'd be looking at under $400 all up. Then spend the rest on a new control scheme and sell the top end 500GB for $499 with a flash only version for $399.