Sorry, but I can't help but feel you're looking at the industry through rose-tinted glasses. There were hundreds upon hundreds of games for NES/Gameboy/DOS/PS that absolutely stunk. The vast majority were rotten, rotten games that were plain unfun from the title screen through to the end credits. I'd happily contend that the opposite is true: that if you go into a GAME store today, the vast majority of games will be at least /ok/. Whilst I don't think it's yet true that the majority of titles are AAA (check the reviews section of your nearest games mag, only a few releases per month are evidently AAA), a declining market for medium-budget games is possibly more of an issue.
And what happened to the $5 games? Since 2007 the industry has seen a huge, massive surge in (successful) indie game development, primarily on PC but also distributed digitally on PSN and 360. It's definitely there, alive, strong and very visible. (Sure, they might take more than 2 weeks to make, but not many games can be made in two weeks to contend well on quality).