The consoles could all do 1080p, but then games would look as bad as current gen games do on low end PC (still better than current gen consoles, but definitely not impressive).
So, in order to add more graphical goodness, they lower the frame size.
You say, let's use the cloud! Well, the cloud is just some server somewhere in Microsoft's data centers that crunches numbers and returns them to the console. This brings some inherent problems. One is latency. It takes time to send data ot the server and bring it back. What's mroe that time will vary from user to user. So it's not like you could offload say, Anti-aliasing because you'd need that data back EVERY frame, or every 16 milliseconds. Obviously, that ain't gonna happen. You could, possibly do stuff like offload physics calculaitons, but again, they would have to be somehting that can't be interacted with ona frame by frame basis. IT would be limited only to things that are not latency sentitive... that's not many things. AI, could be another possibility.
Another issue is that not everyone would have access to it. Ok, so you've offloaded some high level decision making of the AI to the cloud... great, except that 40% of your customers aren't connected, so now they are oign to have a poorer gaming experience than those who are online.
Yet another issue is scalability. Thye more you offload, the more data has to be processed. Imagine turning on your game, and having to wait in a queue, because there aren't enough AI slots in the data center closest to you for you to use.
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