You make a good argument, but there are some holes in it.
First of all, the "Xbox 360 Development Kit" you speak of that costs $99, that's just the XNA Community Games dev kit - it's not what the industry uses. The actual dev kit required to make games for the 360 (not XBL Indie Games) runs about the same as the others, somewhere between $1500 and $2000.
Second, you mention the Unreal 3 Engine costing $350k to license and then royalties on top of that - Valve offers the Source engine pretty much for free, and, while somewhat dated at this point, can compete pretty damn well. Not to mention that whenever Episode 3 drops, it'll get another significant update. All this for buying a game at $50 retail.