Ever since the arrival of the original Galaxy Tab I've been saying that a 7" screen is actually the most useful size for a tablet screen. Its makes for a much more portable device that a 10" screen, whilst offering a useful jump in screen real estate when compared to a phone. I still believe that to be the case. There is no situation where my Transformer Prime (in docked or undocked mode) is more likely to be carried than my MacBook Air - the size difference isn't enough to make the compromise on features worth making. The same would be true of the current iPad.
The arrival of the Kindle Fire and Nexus 7 have very much proved my point. Whilst 10" Android tablets struggle for market share, these two machines look likely to push Android into serious competition with the iPad for sales for the first time.
So are Apple considering a 7" iPad? I can't believe that they wouldn't be. All the technical functions are there to make it possible - a 1024x768 IPS panel is available in 7" format and this would be able to run all pre-Retina display apps without a problem.
The bigger question is: could Apple compete on price? The iPad 2 is currently £329. An iPad Mini would really need to be no more than £249 to compete with the Nexus 7. Despite Steve Jobs dismissal of a 7" tablet I believe Apple have to cover this base to protect their market share in the tablet space. Otherwise the sheer variety and depth of the competition will mean a similar loss of market leadership to the iPhone in the smartphone arena...