They said the pixels have to be small enough that a person with normal eyesight can't tell them apart at the distance they normally hold the device. Then they said that's 300ppi on a phone. At the iPad launch they sort of argued that, you know, people tend to hold tablets further away, so the density can be less while still fitting their definition of retina, etc.
I'm not sure I buy that since I seem to hold both phones and tablets at approximately arm's length and in any case if I play, say, a polygon-based game without antialiasing at the full screen resolution on my 4s I can make out the aliased edges. And I've had routine eye tests so I know that I'm average and not some sort of super human.
In theory if the pixels actually were too small to see it wouldn't matter exactly how source content maps to them — aliasing errors would be present but invisibly small, just as how magazines have been able to print TV snaps for years without someone doing arithmetic on exactly what size the picture needs to be to come out well when the printers are done. In this case I would expect that errors will be visible to the keen sighted but basically not a major problem.