RAM is used for a lot of things in games, the vast majority of RAM in the current generation of consoles is used for textures, animation, sound, and other presentation elements. Following that you'll see a good chunk of RAM being used for middleware such as Havok, SpeedTree, and the system dash. Finally, you end up with the smaller segment of memory used for gameplay.
The 360/PS3 have 512mb of ram, the PS3 splits it into two 256mb sections, but that split is pretty much meaningless.
Adding more RAM will improve the video quality of games because they could use higher resolution textures, the sound quality of games by higher bit rate sound, gameplay would improve because larger and more complex AI nav meshes can be used, the user experience would improve due to fewer loading hallways and larger size levels.
However, since there is no significant improvement in display devices for consoles, support for resolution over 1080p would be limited in value to the consumer. That likely makes the sweet spot of memory for the next set of consoles ~2gb range, it'll be interesting to see if they push for 4gb considering the switch in memory addressing.
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