I'm not too convinced with this just yet, but a rumour is going around now indicating that a 7 (or so) inch iPad will be launching in October with a price tag in the region of $200 to $250. The tablet will be aggressively priced which will allow it to compete with the likes of the Amazon Kindle Fire.
The rumour comes from iMore which also reports that it will come with a Retina display with the same resolution as the new iPad which means it will have a 2048 x 1536 pixel display. Having a smaller screen of between 7 and 7.75 inches means that the PPI could be somewhere in the region of 326 PPI.
As for how Apple will allow developers to work with it, iMore suggests that iPad apps will simply be scaled down to 7 inches which makes touch elements that little bit awkward. What will work on a 9.7 inch iPad might not work well on a 7 inch iPad which creates a little dilemma for iPad developers as they might (and will probably) be unwilling to sacrifice a little on the 9.7 inch iPad by spacing buttons and touch elements out further than wanted. The other option (which iMore dismisses) is that there could be a 3rd screen size for developers to design for. This means iPhone at 3.5, iPad at 7.x and iPad at 9.7 would each need a separate view creating.
The screen size and how developers will need to respond is the biggest part of this that holds me back from believing the rumours. Apple has done well sticking to a 3.5 inch display on ALL iPhone generations and has done well sticking with 9.7 inches on ALL iPad models. Are they ready to fragment a little and put a 7 or so inch model in between?
I'm not saying it wont happen, but I think it might be just unlikely.
Note that a $200 price range would also put it in to the same pricing area as an iPod touch which could cause a few interesting things to happen there as well. We'll find out in October if the rumours are correct.