Does this mean woods are all Size 3 and drop down in size depending on how far from the edge you are?
No. Remember, this table is just a guideline for establishing the attributes of terrain; your forest on the table could be any height desired, regardless of the type of woods. However, this table is suggesting that if you have a small stand of woods, that you should consider assigning them relatively small size values (after all, consider that 1" of heavy woods is no bigger in table space that a Standard base model). It is not meant to indicate that woods change height at their edges. While you certain could use that concept, it could make calculating cover for a model during gameplay a bit cumbersome. As long as you and your opponent agree to designations for the terrain, there shouldn't be an issue.