The 9.7 inch iPad definitely is awesome for the immersive experience it is able to provide with so much screen estate, especially now that it has retina resolution (264dpi, viewed from 40cm distance). However, the e-reader market has been able to make a strong case (at least for some particular uses) for smaller-than-10-inch screens, with sizes closer to pocket book.
But that would require UI redesign?
One of the biggest practical reasons against doing another screen size for iPad is that it could very likely lead to UI redesign, as the physical size of the touch areas would be different. Both for Apple's apps and 3rd parties. However, Apple has been pretty genius with its math around screen sizes and pixels and resolutions. Essentially iPad Mini could use the same pixel size (1024x768) and UI as original iPad and still reduce the screen size to 7.85 inches (163dpi), while still being as easy to use as an original iPhone (also 163dpi).How is that possible? Well that starts with the Apple Human Interface Guidelines, which state any interactive area must be at least 44px by 44px in size. Additionally, you can sometimes tweak this a bit by providing much wider interactive area, while reducing the height slightly.
So a smaller iPad Mini (at 163dpi) could use the smallest physical button size of 6.86 millimeters, while still following the Apple HIG, and more importantly, being able to use the iPad UI and apps just as-is.
Ok, so how would that feel like then?
Well, it's pretty hard to get a feel of a new device, without having a real prototype. But you can try looking and trying the full size version of the picture below inside normal iPad. It is scaled to be physically correct size, when viewed on full screen in iPad.
As a comparison, here's the screen of the original iPhone with the same button measurements.

