I think a 7 inch iPad in the $250 price range, along with the app store and all the other great things that Apple has built, would be devastating to competing tablet manufacturers. Apple employed a similar strategy in the iPod market and the rest of the MP3 player market never recovered. I don’t know whether Apple calls it the next generation iPod touch or the iPad Mini but the result would be the same either way, a lot of units sold to customers that would otherwise have gone to Amazon, Samsung, and others.
This pretty much sums up my thoughts on the iPad Mini as well.
Other than the iPhone and the iPad, all there rest of Apple’s product lineup has screen-size differentiation: different sized MacBook Airs, different sized MacBook Pros, and different sized iMacs. For portable devices especially, the size of the screen has a significant role in the usefulness of the device for the user. Some people need bigger screens and some people need smaller.
A smaller iPad would appeal to an awful lot of people. And not just because it would be cheaper; the size would have appeal as well.
If Apple does create a new iPad with a smaller form-factor its market appeal would be the same as the iPod lineup. There are some folks who own a few iPods (a shuffle or nano for the gym, and a classic or touch for the car / home stereo), and then there are most folks who own just one. It could easily be the same story with iPads: most would only need one or the other size, but some would use both.