...when the average transaction volume regularly exceeds the space available in a block (i.e. we always reach the maximum block size), this will create a market for transaction fees....
Miners can choose and prioritize processing based on fees paid....Doesn't this create a market for fees, without limiting the network processing power to the ridiculous ~7 tps?
No. Unlimited transaction rate means unlimited block size. If the block size was unlimited, miners would simply include all transactions they know about, as long as the fee was non zero. In the short run, this would maximize their revenue. In the long run, users would quickly discover that their transactions always make it into the block chain quickly as long as they is
any fee (even down to the minimum tx fee for relaying). This would drive the fees down to the minimum. That's not a "market for transaction fees."
This analysis ignores the drop in network hash rate that comes from pushing bigger blocks around through the overlay network (a separate but important problem).
tl;dr; Without a maximum block size, fees will trend towards zero.