The tap targets on a 10" iPad are quite big, there was some room to shrink the screen without it hurting usability. Besides, the 7.9" screen size wasn't randomly picked:
The tap targets on an iPad mini are exactly the same size as they are on an iPhone or iPod touch (which also confirms that Apple is using the same equipment to produce the iPad mini screen panels as they used for the iPhone 3GS — they're just cutting the panels in a different size).
“I think there’s a method to Apple’s madness in recommending 44-point-or-larger tap targets for all iOS apps, both on the iPhone and iPad, despite the fact that on the iPad-as-we-know-it, each point is physically larger than a point on the iPhone or iPod Touch. (1 point maps directly to 1 pixel on iPad 1/2 and older iPhones; 1 point maps to a 4-pixel square on the iPad 3 and iPhone 4/4S.) A 44-point tap target on the rumored iPad Mini would be exactly the same physical size as a 44-point tap target on the iPhone.”
We'll see how many apps actually work well though, and which ones have to be tweaked. Not every developer follows the standards.
It's not like Apple even does either. The recent iOS 6 apps store on iPhone is a good example of something where they made the tap targets too small to expand app updates and it was very frustrating. They finally fixed that just recently so that the target was much larger.
At least for existing apps, they've scaled down the effective, physical size of all elements. I'm very interested in how screen text and existing iPad apps look. I'm sure they've done some testing but the readability aspect concerns me a bit.
I'm also wondering if they've made any iPad mini specific changes to OS elements to enhance the usability - namely if there's been any changes to touch targets
It's like a compatibility mode. I expect apps will be able to detect the difference, and many will resize for the new pixel density- except wait, that wouldn't work! Elements would be inconsistent in size!
oops