Why does the cost need to be so high? Chinese markets have many small phone options like Soyes and Servo that cost less than $100. Unfortunately, these devices are potentially loaded with malware.
Can a similar device without malware not be made in small batches? At a selling price of $500 or less?
I actually had a brief email conversation with the folks running the project in the OP. Basically they said they can't get a reasonable-quality screen in that size. No one makes it. They would have to spin up a whole new manufacturing line for a quality, small screen and the cost on that is insane. The screens on the small phones you're talking about are very low quality.
Can a similar device without malware not be made in small batches? At a selling price of $500 or less?