Originally Posted by ghostrider

Come at it from the other way. Your 4" cut square is 4" wide by 4" high...or 8" total if you combine them. If you then subtract the 1" of seam allowances, you get 7". Divide that in half (because it's a square and length and width are the same) and you get a 3½" square. Does that help you see it?

If you consider both directions (length and width) for one element (the seam allowances), you have to do it for the other as well (the square sides).