The move makes the Xbox 360 the first game machine of this generation of consoles to sell for less than $200, a key mass-market price that Microsoft said historically has accounted for more than 75 per cent of all machine sales.
The lower prices ahead of the crucial holiday shopping season -- a period of time when the video game industry racks up most of its sales -- puts pressure on rivals Nintendo and Sony to cut the prices of their machines.
The company said it will cut prices for its entry-level Xbox 360 Arcade, which comes without a hard drive, to $199 from its current price of $279 and it also will lower the prices of its mid-range and high-end Xbox 360 consoles by $50 each.
The new prices will go into effect on Sept. 5.
Nintendo's Wii sells for $249 while Sony Corp's least expensive PlayStation 3, which comes with an 80-gigabyte hard drive and a Blu-ray high-definition video disc player, retails for $399.
"Microsoft wants to drum up demand for the holiday. Microsoft's long-term vision for the Xbox is not to turn a profit today," said Toan Tran, analyst with Morningstar. "It's a way to get a foothold into people's living rooms."
Microsoft said it will cut the price of its Xbox 360 Pro, its best-selling version which comes with a 60-gigabyte hard drive, to $299 from $349 and reduce the price of its top-end Xbox 360 Elite with a 120-gigabyte hard drive to $399 from $449.
The US price cut comes on the heels of a similar price cut for the Xbox 360 in Japan where Xbox sales have been slow.
Redmond, Washington-based Microsoft has sold over 20 million Xbox 360 consoles worldwide since its introduction in late 2005 compared to 14.4 million units for the PlayStation 3 and nearly 30 million Wii units since debuting in Nov. 2006.
In recent months, the PlayStation 3 has outsold the Xbox 360 in the United States.
"Microsoft recognized it needed to do something and I think they also can afford it," said Michael Pachter, analyst at Wedbush Morgan. "They've got to make it up by penetrating more households and selling more software."
After losing roughly $5 billion since it entered the video game console business in 2001, Microsoft turned a $426 million profit in fiscal 2008 at its entertainment and devices division, comprised mainly of the Xbox business.