Here's the glitch: it's not about how much free space I have. It's about the fact that I'm running XP on a Mac with BootCamp - specifically, the MacBook Pro laptop. Apparently, this also happens on the Intel based iMac's.
The error message:
There is not enough disk space on C:\WINDOWS\$NtServicePackUninstall$ to install Service Pack 3 Setup requires an additional 4 megabytes of free space or if you also want to archive the files for uninstallation. Setup requires 4 additional megabytes of free space. Free additional space on your hard disk and then try again.
The solution lies in the fact that Intel Mac's use the EFI format, which Windows does not support. (Feel free to Google more about EFI - all I know is, the solution I found on WindowsReference.com solved the problem for me!)
The fix:
1. Click Start - Run - Type regedit and press enter.
2. Navigate to
[HKEY_LOCAL_MACHINE\Software\Microsoft\Windows\CurrentVersion\Setup]
3. In the right pane, right-click and choose New - String value
4. Name it BootDir and set its value to C:\
5. Exit regedit.
Re-try your SP3 installation, and all should be right with the world.