[Kuruharan]

This is missing the point again -- namely, that simple tool-building (even if we suppose that the Petty-Dwarves retained some skill in this art) isn't enough to distinguish Incarnate from not.

I don't believe that making implements from more than one material qualifies as "simple tool-making." If the Petty-Dwarf weapons were made out of iron that in no way qualifies as simple tool-making, but any metal at all would qualify.

Orcs, for instance, weren't animals in the sense that we think of animals -- but were presumably ripe for being made Elvish pincushions of whenever and wherever they were encountered. I would imagine the Elves progressed rapidly from their evaluation of "cunning two-legged animals" to "believing them to be related to Orcs and creatures of Morgoth" (if indeed there was any meaningful difference between the two evaluations for them).

I don't think that by this point the Elves had enough experience with orcs to make this leap. Even if one assumes a very early date for orcish creation, Elves will have encountered genuine orcs only a couple of times by this point in their history.

In any case, the implication seems to be that the Petty-Dwarves lived "in caves" like animals, or at least like Orcs.

While Mim's standard of living probably wasn't the best, it certainly seemed better than some of the Men that were knocking about at the time. I just don't think that the Elves really knew that much about it.

There isn't much evidence to support the notion of Petty-Dwarves as only slightly less sophisticated than the great Dwarves.

Oh, I don't know. Mim's house was probably similar to the family mansions of most dwarf families in the great cities...only writ small and empty. Dwarves being as stubborn as they are, the Petty-Dwarf way of life probably didn't change much even after they stopped being hunted.

Tolkien never brought this Petty-Dwarf stuff into a finished, consistent form.

I think the easiest way to ultimately reconcile this is A) This probably didn't happen very much or last very long B) the Elves were not very swift in analyzing the evidence in front of them.