oh that's so cute!
I think the mouth is actually a little pocket. See how you can sort of see into it (i think there is even a tongue in there!). What i would do then is when i got to where i wanted the mouth to start i would start knitting with a scrap piece of yarn (something in a contrast colour that will slip out easily late). I would knit for the length i wanted the mouth to be and the swtich back to my normal yarn and carry on knitting as if i had done nothing. Then when i was finished that head i would go back and pull out the stitches in the waste yarn.
That would leave me to sections of 'live stitches' above and below an opening. I would then pick up these stitches in the round and would knit a small tube or pocket (probably justa few rows of knit an then a couple of decrease rows and bing off). This then gets tucked inside the head, creating the mouth.
to shape it into a a more curved smile i might add a little bit of short row shaping in the row below were i would insert the waste yarn.
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