No, I think the smaller size is probably a non-starter for the intended audience. This is meant to be a tool that a lot of these folks are using for hours and hours a day so overall typing and reading experience is paramount, and meant to be a "selling" point.
Cost-wise, yes--we're still grappling with costs of the e-ink screen. It's the by far the largest expense in the unit. We've got a good lead that I unfortunately can't talk about at the moment (under NDA).
A cut-down Linux really is overkill for this, and isn't capable of making some of the other specs happen (battery life, availability), at least as far as we've been able to determine. Custom code is unfortunately where we've been forced to go.