According to recent rumors, Apple is indeed working on a 7-inch, cheap ($200-250) iPad. The Taiwanese publication DigiTimes reports, that the company will launch the new device in August, but the website has also some information on the next 10-inch iPad, as well as on the iPhone 5! The publication states, that the next iPhone is coming in September, and the new iPad will be released in Q4.
Here's an excerpt:
"Pegatron Technology reportedly has landed orders for a new-generation iPhone to be launched in September and a 10-inch iPad to be launched in the fourth quarter, according to Taiwan-based supply chain makers. Pegatron is currently an OEM for the iPhone 4S and new iPad.
Pegatron has already finished expanding its equipment and labor force for Apple's orders."
According to DigiTimes, Foxconn Electronics will be manufacturing the new iPad. We can also be pretty sure that the device will be compatible with the current line of products so we should expect it to feature a 1024x768 resolution display - just like in iPad and iPad 2.
Of course these are just rumors, so take it with a grain of salt, but the launch of a 7-inch iPad seems quite probable.