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MrPennybags said:

Could a smaller HD save space even if it can't save cost? Maybe a component in a PS3 slim?


The most likely case is that they'd continue using standard laptop drives (I believe they're using laptop drives).  The way these drives are constructed, they can contain one or several platters of data.  Adding a platter of data internally doesn't increase the size because they can decrease manufacturing costs by making a single sized drive.

If the future they may be able to release a 20GB or 40GB microdrive or even flash-based version.  The advantage to the flash based version is that flash failures predicably occur well after mechanical disk failures are certain to occur.