The first episode will release on September 29 and no prices have been revealed. The game is fully compatible with Knothole Island and See the Future. We'll keep working on getting more information.
Update: Microsoft has clarified that this is not an extension of Fable II, but rather the retail game broken up into serialized chapters formally titled Fable II: Game Episodes. Xbox Live users will be able to download the initial episode, which serves as a "shell" for the rest of the game, on September 29.
The original game disc is not required to play, and those who grab part one will have the option to purchase subsequent pieces or the entirety of Fable II (think of it like an XBLA trial). If you've downloaded any of the game episodes and decide to spring for the retail disc, your saves will carry over. No per-episode pricing has been announced but we're chasing more details.