What's wrong with the numbers?
The US Video game industry alone was $10 billion in 2004. Putting that into a worldwide perspective, adding in companies like Sony and Nintendo, there's huge money being made. Looking at a $2 billion annual profit alone made by Nintendo is a far cry from the total amount of revenue lost by developers globally over 5 years.
Now, how many people do you know with a modded system? Be it a PS2, PS3, Wii, Xbox, 360, or even an R4 for DS for example. Video game developers make the majority of their money from their video games - much more than what Sony makes off of selling a PS3 for example.
There are very few people who play video games who buy all of the games that they pirated and liked - and usually, the reason it to play the legit copy online due to an anti-piracy measure like a CD Key rather than supporting the developer.
One of my friends was recently let go from his position at video game company that developed a very successful first person action game. Their sales figures were great for PS3 and 360, but the decision to release a PC version of the game concurrent with the console titles proved to be extremely counter-productive. Not only did PC sales account for perhaps only 5% of total sales, it likely gave people a reason to simply download the game and play on their PC rather than buy it for their console. It's a single player game after all.
How many fewer people would buy Final Fantasy 13 if it was on PC, and instead pirate it? Very many. If it hasn't become clear yet, piracy is basically causing single-player computer games to become non-existent because they're not worth it anymore. If piracy did not exist, you'd see computer versions of many many more Xbox and PS3 games because they're relatively easy to port.
That's why piracy on the DS was such a huge problem. Almost all DS games were single player, which made it more difficult to incorporate any sort of effective DRM.
And about your story of Joe who stopped buying CDs, the way I buy PS3 and Wii games are based on online reviews and recommendations from friends. I would have done the same for my DS and PS2 - so not everyone would give up acquiring music completely (or in this case, video games) because it cost them money now.