Before you refund and shipping, take into consideration that the seller is the one who selects shipping method and charges to fee the seller's business risk. The buyer seems to be trying to get your to seriously increase your risk for shipping and delivery disaster. Cheaper shipping will give you less protection for problems. Make sure you fully comply with PayPal's policies for seller protection; you just may need it when you go cheap.
As for a refund, just go to the PayPal transaction on your computer and click on refund. Select the amount you want.
