I have to agree that Kim Jong Il is pretty much batshit crazy at this point. Which means logic might not have anything to do with his decision process.
From what I've seen, DPRK has three big threats it can throw at ROK and Japan: a large contingent of special forces, overwhelming artillery capability, and big brother China.
The North has proven several times in the past that it is capable of infiltrating the South with commando forces, and if things go hot, you can expect to see thousands popping up behind the main lines and causing chaos to the civilian population. The South then has the tough choice of letting them go nuts and accept high civilian casualties, or diverting troops from the front lines.
The next immediate threat is the huge artillery contingent the North has within range of Seoul. While the equipment dates back to the 60's or 70's, most of the world's advancement in the last 50 years has been in accuracy. However, if you're terror shelling a large city, accuracy doesn't matter too much. Throw on top of that the fact that most of the cannons are stored in hardened bunkers, and counterattack becomes very difficult.
The third big problem is China. If the South and their allies could fight the North in a vacuum, they could bring their big guns to bear. Heavy shelling of Seoul would be met with a nuclear counter attack or at the least heavy bombing. However if things get too hot on the North, China will step in to prevent a flood of refugees coming across the Yalu.
As much as Iíd like to see the North taken out, a military conflict is a net loss for everyone. It sucks, but committing millions of Koreans (on both sides) to death to avenge the lives of less than 50 sailors isnít logical.
I think at this point the best shot is to exert as much pressure as possible on the North and China. If Beijing is embarrassed enough by their crazy neighbor they may either pull back on their aid, or possibly eliminate him themselves. Hopefully Kimís son will be a little more pragmatic. If he plays his cards right, he could transition from the isolated crazy person his father was to the forward thinking leader that pulled his people closer to Chinaís system.