It is always a good idea to go back to Lima the day before.

There are no direct flights Cusco to Arequipa. Almost all go via Lima. LAN has one to Juliaca.

I think I might bus or fly to Puno (1 night)
Bus Puno to Chivay/Colca Canyon) (1 night)
Bus Chivay to AQP (1 night)
Next day fly AQP to Lima

Or fly to Lima and take a tour to Paracas or to Nazca.

I'm sure there will be people on the Uros Islands. And probably the others.

Email Allways Travel and ask.

We loved both Arequipa and Puno/Titicaca and both places were hosting large festivals when we visited. Far from detracting from our time in these places, the festivals really made it for us. We spent hours watching the processions, listening to the music and just absorbing the great atmosphere. You won't have a problem getting boats out to Uros as there are too many to count. I would find int difficult to choose between the two (any chance you could squeeze in both?
A link to some of our photos of both places :

http://blog.travelpod.com/travel-blog/candcthai/1/tpod.html

entries 62-64 cover Arequipa and Puno - don't miss Santa Catalina convent.

colca-lodge.com our fav

and/or

Ballestas/Ica/Nasca Lines

mysteryperu.com largest GeoGlyphs in the world truly amazing.

Good luck!

If you didn't already book your domestic flights I recommend the following.
day 1 - early flight to Arequipa - do city tour spend night
day 2 - Colca Canyon
day 3 - Colca Canyon
day 4 - early bus to Cusco or fly
day 5 - Cusco - do city tour and spend night
day 6 - Sacred Valley tour of Pisac market/ruins, Chinchero, Olly and take later train to AC and spend night
day 7 - MP/HP and take later train to Olly and spend night there
day 7 - From Olly visit moray maras/salineras and return to Cusco for night
day 8 - early flight to Lima and do a city tour
day 9 - Lima and take flight to Chile

oops day 7 twice it should be
day 8 - From Olly visit moray maras/salineras and return to Cusco for night
day 9 - early flight to Lima and do a city tour
day 10 - Lima and take flight to Chile

I liked Arequipa a lot and thought Colca Canyon definitely worth seeing. We did a 2 day 1 night tour that we booked thru our hotel and it was interesting with beautiful scenery...one could say breathtaking given the altitude.

Thanks to all of you for all the great ideas. I've been letting them just sort of settle on my mind. If I decide to go to Lake Titicaca and have no plans to do a home stay,would there be any reason to spend more than 2 nights?

We did not do a homestay, so we found two nights sufficient:

On day of arrival, after checking into the hotel, we did a private tour of sites of interest around the Puno area.

http://2totravelperu.blogspot.com/2009/04/day-12-ahayamarka-aramu-muru.html
http://2totravelperu.blogspot.com/2009/04/day-12-chucuito-templo-de-inca-uyo.html
http://2totravelperu.blogspot.com/2009/04/day-12-relic-of-peruano-naval-history.html

The next day, we did the Islas Flotantes and Taquile Island.

http://2totravelperu.blogspot.com/2009/04/day-13-islas-flotantes-de-los-uros.html
http://2totravelperu.blogspot.com/2009/04/day-13-isla-taquile.html
http://2totravelperu.blogspot.com/2009/04/day-13-uros-islands-part-2.html

The next day, on our way back to the Juliaca Airport:

http://2totravelperu.blogspot.com/2009/04/day-14-heading-out-of-puno.html
http://2totravelperu.blogspot.com/2009/04/day-14-chulpas-of-sillustani.html
http://2totravelperu.blogspot.com/2009/04/day-14-traditional-house-in-high-andes.html

While we did pack a lot into our three days in the area, the pace was not rushed ... a good thing when you're at 14,000 feet.

Have a terrific time in Peru.

2 nights is plenty for Puno. A days excursion onto the lake will provide plenty of time to cruise the lake, visit the floating islands of Uros (interesting if a little too much like a theme park)and hike around Tacquile. All easily arrange with any operator in town. The journeys from Arequipa-Puno and Arequipa Cusco are spectacular and it is worth checking out the Inka Express co. to Cusco as they stop at lots of interesting place on the altiplano en route

bookmarking

I want to thank all of you again for your feedback. I have really enjoyed the photos and blogs as well. I had to back off for awhile and work on the Chile portion of our journey. I'm still very torn between Arequipa and Lake Titicaca, but leaning a bit more towards the lake currently. Have been looking into using the Lan South American Air Pass, which sounds like a good deal for us. Called Lan and was told that if I make sure to book on the U.S.A. page there will be no outstanding fees. Does that sound right? How far ahead should I book my domestic flights? Do I really have to spend the night before departure in Lima? Our flight leaves at 1:00 p.m. and if that's cutting it too close,we'll stay in Lima the night before. I'm way too excited and we don't leave until late October!!

hotsauce - I would post your LAN airpass questions on Flyertalk.com - posters are so knowledgeable there - here's the LAN page

http://www.flyertalk.com/forum/lan-lanpass-689/

If your flight out of Lima is at 1pm IMO you absolutely should get there the previous evening at least. And the festival will only add to the Puno experience, so don't let that be a deterrant.

Definitely return to Lima the day before a 1 pm flight!

Photos in and around Colca Canyon and from the bus (Aqp to Chivay and Chivay to Puno). I recommend the new 4-M service if you bus Puno to Chivay (they also go direct between Puno/AQP)

http://picasaweb.google.com/kiwifann/ColcaCanyon

4-M
http://www.4m-express.com/

(I just reserved the day prior using travel agent/hotel. Most agencies will be able to tack 4-M onto a Colca Canyon tour if you are going one way Puno-Chivay-AQP.)

Don´t miss the gastronomic experience in Lima! My personal suggestion is to visit "Restaurante Manifiesto"... take a look here: http://www.manifiesto.pe/en/home.