Apple may begin selling smaller, 7.85-inch iPads next year to compete with newer tablet devices, according to sources within the US firm’s supply chain who are quoted by a DigiTimes report.

The company is rumoured to already be sourcing parts to begin producing the units by mid next year:

In addition to purchasing 7.85-inch panels from LG Display, Apple will also buy panels from AU Optronics (AUO), indicated the sources, adding that makers in the supply chain are likely to begin production of the 7.85-inch models at the end of the second quarter of 2012.

The rumoured size has been selected to allow the iPad to compete with, but differentiate itself from, the 7-inch Kindle fire and a number of large-sized smartphones that manufacturers like Samsung has introduced to the market.

AUO previously fed speculation that Apple was designing a tablet device with a 7.85-inch display after a company leak in October, and such a move would go against Steve Jobs’ comments, which include: “10-inches is the minimum tablet size”, and “7-inch tablets are tweeners; too big to compete against a smartphone, and too small to compete with the iPad”.

Apple is also thought to be launching the third version of the iPad during the first quarter of next year, in response to the growth of tablet PCs, which are expected to reach 60 million units by the end of this year

Previous iPad rumours have included speculation that a thinner iPad 3 will land in March. Back in October, analysts predicted that production of the iPad 3 would be under way before the end of the year, by which time an initial 1 million devices are thought to be ready.