How about a 4" iPhone at 1200 by 800 resolution? By my math, the screen would be 3.35" tall and 2.23" wide (same aspect ratio as current iPhones 3:2).
Also, the PPI would be slightly above the current 326 (it would be around 360PPI).
The problem is increasing fragmentation and the challenges it imposes upon both app development and customers' Apple experience. Granted, it'll never be as bad with iOS as it is with Android since there's only one company producing the devices and therefore in control of things. But, as time goes on, customer preferences change, and even Apple, with its reality distortion field (of which I am, incidentally, an incurable victim), is not immune to the repercussions. For example, a lot of people deem the 3.5" screen size just too small for a top-tier phone released in 2012. This, in turn, necessitates a solution for the screen size / resolution problem. A solution which introduces as little fragmentation as possible.
At the moment there are iOS devices with two different resolutions that are not double/half the size of each other (iPhone: 480x320 / 960x640; iPad: 1024x768 / 2048x1536), and two respective sizes / form factors (iPhone: 3.5" / 3:2; iPad: 9.7" / 4:3).
Currently it's straightforward for app developers to design software for both the iPhone and the iPad; because there are essentially only two resolutions and form factors, the apps effectively need to be designed for just two target devices. This was, of course, Apple's intent behind doubling the resolution. The biggest difference is that Retina displays call for Retina-grade graphics, but since the Retina resolution just doubles the number of pixels vertically and horizontally, downscaling is straightforward.
Now, if Apple introduces a new resolution for iPhone into the mix that is not double-Retina (a ludicrous, albeit deliciously intriguing concept at 1920x1280), it will essentially act as a third target device, therefore increasing the workload of app designers who need to support the new resolution. And of course, there's the question of PPI. Just by upping the screen size would obviously mean that PPI goes down. To combat the drop in PPI, Apple could introduce a "non-standard" (in iOS terms) resolution like 1200x800, as mentioned in your post. This would mean that apps would need to either include graphics for two different resolutions (Retina, which could be directly downscaled, and the new resolution), or just provide graphics for the highest resolution and leave the scaling to be done in software. The former option would obviously have heavier impact on app sizes, particularly with more graphics intensive apps (think Infinity Blade, etc.), and the latter could produce substandard results.
Screen size change would also force designers to rethink their apps' layouts. If the new screen size would be, say, 4.0", would it be best to just let everything look a bit bigger, or should the graphics be scaled down so that they would look the same size as on the 3.5" screen, therefore leaving more screen estate either unused or better utilized by other things? Options would be, then, to either have "bigger buttons" or a redesigned layout.
Apple definitely has to make a judgment call, and it's going to be a tough one. The 3.5" screen size is inevitably approaching the feature phone space. Then again, not everyone wants a comparably humongous device with a screen like 4.7 inches or more. The most important thing from a design and fragmentation control standpoint is that Apple retains the 3:2 form factor. Still, any decision that leads to an iPhone screen size that is different from 3.5" or a resolution not 1:1 scalable with existing models will pose Apple problems that they cannot take lightly.
Whatever Apple decides, there's bound to be quite a bit of complaining from customers. If Apple wants to continue selling the iPhone as a singular model (a strategy that has greatly benefited them thus far), they need to estimate what would be the best decision not only for the 2012 iPhone, but also for the next few models. To be more specific, Apple can't just introduce a new screen size and resolution this year, and do the same the next. That would expedite iOS fragmentation, which Apple has been thus far able to combat successfully.
