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A 4GB hard drive consists of 4GB of unformatted space. You cannot store files that the ipod's firmware/hardware can understand on an unformatted volume. By formatting the volume you end up with a logical space that is slightly smaller than 4GB. The rest of the space is used up by drive structure information (partition boundaries, allocation tables, etc...) The cluster size used for the format also affects the resulting partition size and what kind of data/files can be housed there and how they are read/written. Unrelated tidbit: hard drives are actually built taking into account that some sectors WILL fail. When they do, others take their place. They essentially have additional "reserve" or "backup" sectors on the disk on purpose.
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