Within MS Word only, the Versions dialog contains two buttons that allow the user to easily compare two versions of the same file.
If you select one version, then the Compare to Current option will be enabled, and clicking this will open a comparison between your current version and the selected version (version 3 vs. version 2 in this case).
If you select two versions, then the Compare Selected option will be enabled, and clicking this will open a comparison between the two selected versions (version 2 vs. version 1 in this case).
The end result in both cases is that a new temporary window will be opened showing the comparison between the two versions of the file. You can use the Display for Review function in the Review ribbon of MS Word to control the style of how the comparison is displayed. Once you are done reviewing the differences simply close the window.