I'm extremely curious- where did you come up with $550 price difference? The I7 would cost me $30 more, the memory would cost less, and the graphics card would cost me a bit more, I think. EDIT: oops, forgot about motherboard
Yes, you do need a very sexy motherboard to get the most out of an i7. Actually, I was mistakenly looking at the Nehalem that is one model up from the one you were looking at. It's around $630 or so. With the one you're looking at, the price of the system would be cheaper.
What would make your system faster? The proccessor (though I7 is fast), or more memory?
System speed is dependent on a few things. Using Civ, the only thing that really matters is raw clock speed, having enough RAM, and a decent video card. Clock for clock, a 2.6 GHz dual core will really be no slower than your new fancy i7 using
similar equipment while playing Civ (that means no DDR3 RAM.) DDR3 will give the i7 an edge with Civ obviously, and a big boost to everything else. Where the i7 really shines, though, is in multithreaded apps. My machine runs almost as fast as my partner's, but when we did a comparision with some of her nifty software, her machine left mine in the dust. (The stuff we ran was graphic card independent, it was just raw number crunching. It had to be written by some very very geeky elves or something...) But clock speed and lots of RAM make anything faster. For gaming, having that isn't enough. You need a very good graphics card for some of the new games. If you don't, you wind up with a bottleneck. (Civ note: My Radeon HD 3450 cheapie only has about 40% untilization playing Civ in Hybrid Crossfire mode. I obviously don't need a sexy video card for Civ.

)
I'm not an AMD fan-girl, but for me, there wasn't any point in spending the money for an i7. I'm not a real gamer, except for some card games and Civ, so I didn't really need a lot of power. I went quad because I sometimes do some video transcoding, and I got a little tired of the old dual core being so slow. And of course, I overclocked it too much and set it on fire trying to get some more performance out of it.
And, do you have any opinions on the graphics choices? More memory, or newer card?
Well, if you're going to be playing some of the newer games or have plans to run something with a lot of graphics requirements, you are going to need a good card. I'm told that graphics memory doesn't really matter above 512 MB, but I'm not sure about that. What is important is the interface to your card. My card is 64 bit, and it's fine for what I do. Many of the new cards have a 256 bit interface, and perform very well with pretty much anything. Just as an example, my sweetie has two of these:
http://www.newegg.ca/Product/Product.aspx?Item=N82E16814102768
You can go a lot crazier than that if you want to. Buy the card which will give you the performance that you are looking for, without killing your budget. You have to weigh what your requirements are together with your budget. I've heard of some people paying upwards of $700 for a card, and then buying 3 more for quad Crossfire.

Who needs that kind of power? I'll bet you can fry an egg on the top of that case, too.
And I'm guessing by the fact you have all that RAM that you're running Vista or XP64, would you reccomend I switch to that or stick with normal XP?
I'm running Vista HP 64, and I have had zero problems with it. (With the exception of Firefox. Service pack 2 broke it. Big surprise there.

) If you really want to get the most out of a big quad core system, you need a 64 bit OS. I would be reluctant to get XP64 because MS may not support it for much longer, but that's a personal opinion. YMMV.
Also, with Nvidia cards, I have noticed a whole buch of people posting on CFC about issues with Vista and graphics problems. Many of these people have Nvidia cards. I've done some research with our room mate (electrical engineer and really smart guy), and it seems that Nvidia has had driver issues with Vista for a while. They make very good cards, and it wouldn't stop me from buying one, but it is something to consider.
Good luck with your system.
-LM