Compare with Latest version
seems clear. It compares files against the latest version in TFS. So you'll get all the differences between the very latest version checked into source control and whichever folder you're comparing against.
Compare with Workspace version
might be confusing, but is actually pretty simple. TFS keeps track of the version of the file which you've retrieved into your workspace. This is usually the latest version, or pretty close to that, but that doesn't have to be the case.
When using the Get Specific Version option you can retrieve any version of a file to your local workspace. You can even retrieve files from different versions into your workspace. When you select this option, a comparison will be done against the version that is currently in your workspace.
Comparing with workspace version actually compares the edited file with the version of file at the time you checked out (compares exclusively your changes).
Comparing with latest version compares the edited file with latest version of file present at your code repository i.e. it might include changes made by your colleagues.
@serhio's 3/28/14 answer is an excellent narrative answer. However, I'm sure many (including myself) needs that backed-up with an example, and here it is:
For everyone, "Lastest Version" = Changeset # 1.
You "Get Latest".
For you, "Workspace Version" = Changeset # 1.
You make changes.
Developer B "Get Latest".
For Developer B, "Workspace Version" also = Changeset # 1.
Developer B makes changes.
Developer B "Check-in".
For everyone, "Lastest Version" = Changeset # 2.
For Developer B, "Workspace Version" = Changeset # 2.
For you, "Workspace Version" still = Changeset # 1.
You "Get Latest", "Merge Conflicts" (if necessary) and "Check-in".
For everyone, "Lastest Version" = Changeset # 3.
For you, "Workspace Version" = Changeset # 3.
For Developer B, "Workspace Version" still = Changeset # 2.