Makes perfect sense to me... With the next iPhone and iPod Touch having a screen no bigger than 4" (almost the same dimensions than the current iPhone), the 7.85" iPad mini and the 9.7" iPad... they should have all usable sizes covered.
No need for larger "phone" and no need for smaller "tablet", it will be a great tablet to fit women purse, as well as cheap enough for kids at school... The modern version of School Tablet:
Perhaps also small enough for very mobile tasks where the iPad 9.7" is more practical for reading/office computing tasks.
No need to redesign current Apps UI that will stay big enough to be used with fingers (even better for small hands... such women, kids, asian market, etc...).
A $299 would make also a perfect sense price wise... just right between the iPod Touch and the first iPad model.
If you add iOS 6, the current gazillions of Apps, the Apple eco-system with iCloud, etc... it will be no reason for anyone to buy a Kindle, Android or even Windows Tablets... And they will definitely kill anyone else if they just release "Gate Keeper" for iOS, to allow anyone to run Apps from the App Store, or from Signed developers, or from anyone.
If you are worry about "Virus/Trojan/etc..." just run your iOS device with AppStore Apps only... If you have a specific need, you can still run Apps from trusted developers... That would also solve App that don't respect Apple AppStore rules, use personal APIs, etc... No need to jailbreak anymore.
And it would be one more step for the merge of OS X and iOS. So, in that large scheme strategy, a iPad mini 7.85" would make sense... And it also makes sense to have Cameras for Facetime (on a $299, since the iPod Touch does also have Cameras), but maybe also a version without Camera (maybe the $249) for the School business...
Spid