Apple is potentially developing a smaller iPhone that would be cheaper and better able to fend off inexpensive Android phones, Bloomberg reports.

We’ve heard previous rumors that a smaller iPhone was in the works — akin to how the iPod Mini followed the original iPod. One person who saw a prototype of the smaller device said it was about a third smaller than the current iPhone and that it lacked a home button.

Apple was bound to offer a lower-cost iPhone eventually, especially now that cheaper Android phones like LG’s Optimus One series have proven successful. A lower cost option will also make the iPhone more appealing in international markets.

Apple is apparently aiming to sell the smaller iPhone for $200 without the need for a two-year contract. That would be a significant change from the iPhone 4, which retails between $200 and $300, but requires a two-year commitment. By avoiding a contract, users would be able to easily switch cellular carriers, something that would also appeal to international users.

If Apple actually moves forward with the plan, it will have to persuade consumers that a smaller phone is still worth paying $200 for. Although, with a $200 price point, it’s possible some carriers would offer the smaller iPhone for free with a contract.

According to Bloomberg, Apple is also working on a dual-mode iPhone that would be able to work across GSM and CDMA cellular standards — the technologies used by AT&T and Verizon, respectively. That doesn’t come as a huge surprise, as we reported recently that the Verizon iPhone runs a wireless chipset that could potentially run on AT&T’s network — a clear sign that Apple is aiming to support both standards in the iPhone 5.

Apple is also developing a technology called universal SIM that would allow consumers to switch between multiple GSM networks without having to switch out traditional SIM cards. Such an innovation would make it easy for users to jump between networks, and if paired with an inexpensive iPhone without a contract, it could lead to new-found freedom for cellular users.

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