(Update: a reader has pointed out that the Tapwave Zodiac was very similar to what I'm describing here, though based on PalmOS. Sadly, despite great enthusiasm among its users, most people -- including me -- never heard of it, and the company has gone out of business.)
This computer would be slightly larger than a standard paperback book, with a good full-color screen, a pen for input (and no keyboard), WiFi connectivity, and game controls. It's a convergence device intended for the following functions:
There are three major standards for video aspect ratios today. One is the 4:3 ratio used by older movies and (still) many current television shows. Then there are two "wide screen" formats typically used by movies: 1.85:1 and 2.35:1.
A screen aspect ratio of 1.85:1 forms a nice compromise among these. Movies such as The English Patient will completely fill the screen, while appearing exactly as they did in the theater. 4:3 videos (and video games designed for the TV) will be slightly letterboxed on the sides, and 2.35:1 videos will be slightly letterboxed on top and bottom, but neither of these appears extreme, as you can see below.
The actual dimensions still need a bit of hammering out, but in the examples above, the screen is about 360 pixels wide and 200 pixels tall, and the videos look quite good. On the other hand, the Nokia 770's display is 800x480, and 4.13" diagonal; that's nearly the same 1.85:1 aspect ratio, and could work well for the dream machine too.
So, the dream machine is designed to work in either the horizontal or vertical orientation. For horizontal games, you would use the d-pad with the left thumb, and control up to four buttons with the right. The two additional buttons in the lower-left corner could also be used for rare special functions, as long as they don't need to be pressed at the same time as the d-pad.
In vertical mode, you still control the d-pad with the left thumb, but you use the two buttons near the corner of the screen with the right. (Two buttons are typically enough for old-style arcade games, and of course will suffice for any custom software written for this device.) The four buttons that are now above the screen would not be used. The d-pad and two buttons at the bottom would also be used for such things as navigating e-books.
Software development would be encouraged by providing a standard development tool chain, which could run on any Unix-based desktop system (e.g. Linux or OS X), or even on the device itself.
Finished applications should be provided to end-users as simple files they can just download and install or run, without having to worry about things like library dependencies. It is hoped that many of the users of this device would not be technically savvy Linux users, and so app installation (and deletion) needs to be as easy as possible.
However, the text entry (keyboard emulation) software would be an open module of the system, so if developers want to provide some other means of text entry, they could do so, and all applications would automatically support it.
Hardware-accelerated 3D graphics is desirable but not a requirement.
The touch screen should have resolution sufficient for writing, drawing, and interacting with objects on the screen. Pressure sensitivity is not necessary.
Onboard speakers are not necessary; instead, a stereo headphone jack (like on the iPod and many other devices) will suffice.
Since none of the major manufacturers seem to be making such a device, it's worth considering what would be required for a small group of hobbyists to "homebrew" one.
Based on the above requirements, the Nokia 770 is probably a good reference machine. It uses an ARM9 processor at about 220 MHz, with a DSP that handles multimedia tasks. It has a total of 192MB of RAM on board, and uses 64MB memory cards.
A similar amount of power might be had from something like the gumstix "connex 400xm", which uses an Intel XSCale PXA255 running at 400MHz. This lacks the DSP but has almost twice the clock speed, so might be able to handle multimedia tasks in software. The Gumstix boards can drive LCD displays up to 800x600 or so, as long as they have a digital interface.
For the display, a number of possibilities are available at EarthLCD.com, including integrated touch screens and add-on touch screen kits. Most of these are too expensive, but some are quite reasonable, like this 7.8" color 640x480 touch screen for $99, or the Seiko C555002. That suggests that, with enough searching, an appropriate screen might be found. For example, TouchWindow.com offers add-on touch screen kits which convert an ordinary LCD display (like this one?) into a touch screen. EZScreen does too; their EZ-0423L-AGH-AN-W4R looks about the right size and is only $36.