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A finite-element beam propagation method is applied to the optical analysis of small pixel liquid crystal (LC) (micro)displays. It is shown that the near-field profile is affected in these devices by diffraction, even for the ideal case of homogeneous pixels. The influence of the pixel size on the diffraction profile is shown and a fundamental contrast limit is demonstrated. The importance of LC materials with high birefringence is confirmed for small pixel LC devices as these improve the contrast for a fixed pixel size. Simulation of the pixel walk-off phenomenon in gray pixels due to anisotropy in the longitudinal direction illustrates the importance of including the full dielectric tensor in optical modeling of small pixel devices.