Many people do not understand the Chinese people's appetite for luxury goods. Chinese people like to show off their wealth. Flashy mobile phones are one of the items that they use for that purpose.
Expensive mobile phones are quite common in China. Look at Nokia N95 and the 8800 series, LG Prada and HTC high end PDA phones. They all retail at close to or over US$1000 in China. Not to mention Vertu phones which are sold for more than US$10K. They are selling quite well in China too. Go to the Vertu website (www.vertu.com
), you can see that the site is available in only 3 languages - English, Russian and Chinese. This tells a lot on how the important the Chinese (and Russian) market is.
Apple can simply price the iphone at around US$1000 in China and sell them without contract. They may make less money this way but it is a good way to crack open the Chinese market and raise awareness of the brand. This is key if Apple wants to sell more ipods and Macs in China.
Many people here mentioned about fake products in China. It isn't an issue because only those people who do not have money to buy the real things would buy them. People who can affort an iphone will try very hard to make sure what they get are real. (look at the Louis Vuitton shop in Paris. It is swamped by bus-loads of Chinese tourists because the LV bags sold there are garranteed real.)
The vast size of the Chinese market can distort common sense. There are close to 1.4 billion people in China. Mobile phone users are close to 500 million. If 2% of the mobile phone users were to get an iphone, Apple can sell 10 million. If I were Steve Jobs, I'd do anything to pry open this market.