Yet the smaller sensors do get better
It's a basic law that the bigger the quadrangle that gets hit by the light, the better the technical quality of the photo. hat aspect of photography isn't going to change any time soon.
However, if you look at the dynamic range performance I get from my current main camera (an Olympus Pen) and my first DSLR (and Olympus E-510), the difference in available dynamic range is frightening. It's like comparing slide film to negative. In this respect, I think per pixel performance improves over time, in fits and stars (at the moment, it's hit a wall).
Zoom lenses? Haven't shot with one of those in months. Thanks to ebay, I have a small set of primes. I'd love one of the quality zooms but, obviously, they remain quite expensive (and my primes are still faster).
Subject isolation (using narrow depth of field) on a smaller sensor? Hmmm.... Very fast lenses on Four Thirds (thinking lenses like the Panasonic 42.5 f1.2) are expensive. Depending on what you want to do, I think there comes a point where so-called full frame (35mm) is more economical.
Medium format manufacturers? I think Pentax and Leica might take issue with your assessment (and a modest Pentax system can be had for the price of a Ford Focus :-).
Biting the hand that feeds IT
