I believe their business model includes generating additional revenue from shipping but there is a "tipping point" where sales are reduced far enough to reduce the bottom line (ie: the profits generated from the shipping are < the additional profit potential from the lost sales.) I assume they have projected this and are happy with their model but it sure sucks from our vantage point.
On your example of a single item @ < $10, they lost money on that sale after factoring in packaging, postage & labour to prepare your order but even if they put a premium on all orders under $25 for example, that would easily solve it. Most people could put together a $25 order.
Exactly. The term "Shipping" factors in the cost to prepare your shipment. It's not just the cost that carriers charge a company. Maybe they could offer a $3 discount in return for shipping your $300 lilliput in its own box with a sticker with your name on it.