1) Apple for awhile now has lost it's vision. They only cater to large mass market appeal.
2) They want maximum profits and a smaller iPad probably won't give them that margin they prefer even if it is less "powered". Add to that a less powered tablet may not be able to handle ios5 and future iterations and I think that's something Apple is proud about ..performance and intended "experience".
Disagree. Remember a decade ago Apple was coming out of turmoil and near death. Rather than cater to mass markets they've built the mass market. Case in point. When you look at the PC market they are all catering to the mass market with a bunch of features that look good on a spec sheet but make little sense in a computer (things like Blueray drives, HDMI ports and other convergence stuff)
Guessing on profit margins is a fool's errand. Price is determined by Build of Materials and markup. What differentiates Apple from other companies is the amount of risk they'll take to launch a product. They plan on selling millions of a given device and so they order parts based on that projection which nets better pricing and the ability to make more margin at a given price point than their competitors.
I'm not sure a 7" iPad is doable at $250 but i'm sure it's possible at $299 based on some potential supplier improvements.
1. Display - if Sharps IGZO tech is ready now it would help deliver a great screen at lower pricing.
2. We've already got smaller, cheaper 32nm A5 processors.
3. Battery tech - The new iPad has a very dense battery which should mean less is required for a smaller iPad. Less weight and cost.
4. Higher integrated parts. Now it's easy to be Wifi/Bluetooth/GPS/FM from a single supplier and all of your inertial stuff (Compass/Accelerometer/Gyro) from a supplier in one chip. Easier to implement and test.