Nano, no problem
What could they take out to make a nano size phone? For the sake of software, the screen MUST remain the same number of pixels, though it could be physically smaller. The CPU must remain the same with the same speed.
They could take out the GPS and the WiFi. They could take out the 3G. This reduces size and power, allowing them to use a smaller battery. They could take off the black top and bottom sections, leaving the front literally all screen. They might go plastic over the screen instead of glass, for weight reduction. And that's about it, but that should be enough.
Removing WiFi is acceptable as long as you can use the iTunes and App stores over the cellular network. They might reduce the size limit from 10MB to 5MB for over the air purchases.
Now you have a smaller, lighter unit that runs all the very same software, has almost all the same features (no GPS but still location manager is there like in the first gen iPhone), and it could be significantly cheaper. But who cares the price, that never bothered me because it is nothing compared to the enormous $70/month you pay to those robbers at ATT.
