Amazon just announced the new series of Kindle fires with upgrades of quality, bigger sized devices, and heavy discounts to compete with Apple and other tablet producers. It can sell its hardware near or at cost and try to make money on the services it provides. Apple makes a lot of money on hardware so it is in a difficult position especially if the quality gap get narrowed. Apple can't ignore Amazon anymore as in doing so Amazon can steal a lot of market share. Amazon is one of the few players ( except Google ) that does not need to make money on hardware. To sacrifice margin on tablet may not be a good choice for Apple either.
However, it may consider discounting its e-book business to undercut or make sure Amazon can't get much profit to subsidise its loss making strategy on tablet hardware. E-books business is not a big business for Apple, so it can sacrifice it to fight Amazon's core business just as Amazon trying to undercut Apple on hardware. Apple can sell tablets with premium quality and discount book prices.
Apple may even consider buying or working with a small niche e-book player who has the expertise on book business to compete with Amazon while utilizing its huge IPAD audiences.