Smaller, cheaper iPhone in the works?

The Apple rumours continue to fly this week with word that a smaller, cheaper iPhone is in the works.

iPhone Nano rumours aren't new, but Bloomberg is reporting that Apple's now working on new versions of the iPhone in an attempt to slow the growth of competing devices coming from the Android camp.

One version would be cheaper and smaller than the most recent iPhone, "said a person who has seen a prototype".

The report says that Steve Jobs, currently on medical leave, wants to narrow the price gap that has made phones running Android more popular than iPhones.

The person who has seen the prototype says Apple is considering selling it for about US$200 without any two-year contract having to be signed.

It's probably not iPhone 5 but could it be Apple's September surprise?