Steve Jobs famously stated that an iPad with a screen smaller than 9.7-inches wouldn't feel right, but that was then. Apple's run by Tim Cook now. The well-connected John Gruber of DaringFireball recently said on a podcast that Apple has a smaller iPad with a 7.85-inch screen floating around its labs.
The iPad "mini" is not a smaller version of the new iPad (third-gen) that was released last month. Gruber claims that he's positive that Apple is at least experimenting with a 7.85-inch iPad with a 1024x768 resolution display (same as the original iPad and iPad 2).
"It's just like the 9.7" iPad shrunk down a bit. Apps wouldn't need to be recompiled or redesigned to work optimally on it. It's just the iPad smaller."
While Gruber is not certain that Apple will ever publicly release the smaller iPad, he also thinks that Apple might have prototyped it to counter Amazon's Kindle Fire.
Gruber's new ripple isn't the first time we've heard of a 7-inch iPad. It's actually been rumored for a very long time.
Frankly, given how successful the new iPad and even the $400 iPad 2 is doing, Apple doesn't really need a smaller iPad. The only reason we can think of for a smaller iPad is if Apple decides to drop the iPad 2 next year and release a smaller iPad to replace it to save on production costs. It'd be like how Apple kept shrinking the iPod Nano or iPod Shuffle.
Also take into account that the resolution would be that of the last-gen iPads. Moving forward, Apple's going to want Retina 2048x1536 resolution apps, not apps with lower resolution.
I know lots of people who are still not tablet owners because they feel the 9.7-inch iPad is still too large for them. A 7.85-inch iPad would sway them instantly. What's your perfect tablet size? 7-inches? 9.7-inches? 10.1-inches? Perhaps you're even holding out for Toshiba's 13.3-inch monster tablet?