Microsoft is apparently working on a smaller 7.5-inch Surface that will cost $399 or less. But unfortunately the rumor says that it will not be released until Q1 2014...
The 7.5-inch display will have a resolution at 1400 x 1050, that means a 233 ppi.
So if the rumor is true that it will not be launched until Q1 2014 that resolution and screen will be old, and the price will be too high for what you get at that time.
So Microsoft will be too late to the game again.