In terms of who's screwing whom, it's hard to point fingers accurately.

It's easier to argue that Microsoft is screwing its partners, since they've been doing business with Microsoft forever under the assumption that Microsoft wasn't going to go into business against them.

With 7" tablets, the gorilla in the room is Amazon's Kindle Fire. Google clearly had to hit the same price point as the Kindle Fire, and they appear to be pursuing a similar strategy, not unlike the classic shaving kit model ("give away the handles, sell the blades"). Without market share numbers, it's hard to say how much the other vendors are hurting, but I seem to recall that Amazon is leading the market with Barnes & Noble not too far behind. If the future of the 7" tablet market is all about media consumption on at-cost or subsidized devices, then this is simply Google acknowledging reality.

Also, part of what seems to be going on here is a "share the love" approach. The original Nexus phone was made by HTC. The next two by Samsung. The closest thing to a 10" tablet Nexus would be the Motorola tablet (or perhaps the Samsung they gave away at last year's Google I/O). Then this 7" tablet by Acer.