Type 1 and Type 4 refers to the engine. The typical 1600cc Volkswagen Bug engine is called the Type 1. The VW Bus engine is called the Type 2. The Type 3 was used in such cars as the VW Variant(Squareback).
I don't really know much about the subject myself, but from what I've gathered the Type IV engine is basically the culmination of 30 years of experience with the previous air-cooled engines. In short, the Type 4 is the most powerful, most reliable air-cooled VW engine ever built.
I want a VW Bug as my first car, but I don't want the traditional slug.

You can build up Type 1 engines, but everybody does that. I read about it a little bit, and became quite interested.

It would be cool.
Edit: Cool, thanks Zenmervolt.