The appliances you mention in your comment clarification to the question will never be using a windows PC, so low level windows programming is not a requirement in that case. In fact, I'd say its undesirable. Prototyping is about speed. It's about how fast you can put something together to show potential investors or upper management or some other decision maker.
You wouldn't want to spend the extra time with low level C and Win32 api until the project requirements were flushed out enough that you knew that was an absolute requirement for the final project deliverables (perhaps a server/PC monitoring tool?). Until then you want speed of development. Lucky for you the industry has tools for rapid prototyping and development of hardware like you describe.
My Preference for Prototyping with Embedded Development
As for my opinion as a developer, I like the .net microframework (.netmf) simply because I'm already a Microsoft .Net developer and can transfer a lot of my existing skills. Therefor I prototype with a FEZ microcontroller using C# under Visual C# Express 2010 (free as you required). Its fast, easy and you are working on the core of your project in minutes.
If your experience as a developer is different, you may look for a micro controller which is programmed using BASIC, Java or some other language to help with the speed of development by reusing your core skill set.
Addressing your Question Bounty Comments
Astonishingly large portions of the embedded software can be developed
on the desktop computer as opposed on the deeply embedded target. This
avoidance of the "target system bottleneck" can potentially improve
productivity by an order of magnitude, if done right. However, to
develop embedded software on the desktop, one needs to simulate the UI
components, such as displays (both segmented and increasingly
graphical), LEDs, knobs, and buttons. I'm looking for such UI
components written in plain Win32 API in C for easy integration with
embedded code to be developed and tested on the desktop Windows.
I did embedded development full time professionally for well over 4 years as well as many years surrounding that part time. While what you said above is somewhat true, it will not save you time or money which is why everyone is confused about the motivation for this strategy. We spent years trying to put out a windows emulator for this company's hardware devices that would theoretically save time for prototyping. It was always a pain and we spent many more hours of work trying to emulate the experience than if we just went straight from sketched UI drawing specs to real development. The emulator lagged behind hardware development and often wouldn't support the latest features until 6 months or more after the hardware was released. It was a lot of extra work for very little value.
You will spend more of your time developing non-reusable win32 platform code and hardware emulation components than actually writing the code for the core project itself. This only ever makes sense for hardware vendors who provide this emulator as a 'value add' tool to potential 3rd party developers, but it does not make sense for prototyping new hardware designs.
Modern development environments like Visual C# Express 2010 with a FEZ microcontroller can compile, push the project output to the microcontroller, and then begin debugging just as fast or faster than you could compile and run a low level windows app in C emulating LCDs or LEDs or switches, etc... So your comment, "improve productivity by an order of magnitude", is simply no longer true with modern tools. (It may have been prior to the last 10 years or so.)
If you really, truly just want to simulate the embedded hardware visually on a PC use something like adobe flash to mock up a UI. But don't duplicate code by coding for windows when the final device you are prototyping won't be running windows (maybe it will be, but you didn't say that). Use the fastest most reliable prototyping tools available today, which is unequivocally not low level C and win32 api!
Maybe use StackExchange for Electronics?
Because this is a development oriented site, discussion about the merits of specific embedded hardware isn't really relevant. If you decide to refocus on using microcontroller electronics for prototyping (Arduino, FEZ, Propeller, Basic Stamp, Pololu, etc) you might ask for electronics hardware advice on stackexchange for electronics. I will say that most of those platforms are designed to facilitate the prototyping of LCDs, LEDs, buttons and interfaces as you outlined. You can usually assemble a few pre-built modules in a matter of minutes and be ready to start coding your project. Huge time savings can be had here.