I'll give this a shot. First, Apple has margins that any other manufacturer would kill for. If they felt that a credible competitor might actually gain a foot hold they could cut back on that margin a lot and still make a decent profit. Second, Apple has incredible economies of scale. Since they are buying in such large numbers, the parts that go into an Apple product cost less that do the parts that do into a competitor's product, even if they are the very same parts.
People have bought iPads because every other tablet was a piece of crap in comparison. And they have bought 9" iPads because that's all that existed. We don't know if a fair number of those people would have bought a 7" if it was available.
I believe that it is possible that Apple will come out with a 7" iPad. I wouldn't want to put any money on it, but I think it could happen. And I think they could make it as cheap as Amazon's tablet with more features and capability (but less than the current iPad).
Personally, I have no interest in 7". I am with the crowd what would like a slightly larger iPad, but I could see people who can't justify $500 part with $200 for a less capable, smaller version of the iPad. But, I agree that we will not know for sure until we see it at a press conference.