The current iPhone has a 3.5" screen, with a resolution of 960x640px. In thinking about a 4" screen, one wonders what the new screen resolution would be. Simply making the screen bigger, but reducing the pixel density, doesn't seem like Apple's style.
While the aspect ratio would need some adjustment, making Retina displays slightly larger seems like a simple solution. Apple could create 4" displays with the same 1024x768 resolution as the iPad. Not only would this make sense from a pixel-density standpoint, but the existing catalog of 1024x768 iPad apps would be supported natively.