This device is not eligible for the requested build: Also sometimes displayed as an "error 3194." If you receive this alert, update to the latest version of iTunes. Third-party security software or router security settings can also cause this issue. To resolve this, follow Troubleshooting security software issues.
Downgrading to a previous version of iOS is not supported. If you have installed software to performunauthorized modifications to your iOS device, that software may have redirected connections to the update server (gs.apple.com) within the Hosts file. First you must uninstall the unauthorized modification software from the computer, then edit out the "gs.apple.com" redirect from the hosts file, and then restart the computer for the host file changes to take affect. For steps to edit the Hosts file and allow iTunes to communicate with the update server, see iTunes: Troubleshooting iTunes Store on your computer, iPhone, iPad, or iPod—follow steps under the heading Blocked by configuration (Mac OS X / Windows) > Rebuild network information > The hosts file may also be blocking the iTunes Store. If you do not uninstall the unauthorized modification software prior to editing the hosts file, that software may automatically modify the hosts file again on restart. Also, using an older or modified .ipsw file can cause this issue. Try moving the current .ipsw file, or try restoring in a new user to ensure that iTunes downloads a new .ipsw.
BTW, if you really had a 2G iPod. iTunes would say 4.2.1 is the latest iOS.
Be careful if you really do have any iPod touch 3rd gen if you want to load the latest version of software. I do, and I have had nothing but problems. My pod is slow in responding and it sometimes freezes as I try to use some of the apps. My MacBook has also been affected and I bought the touch & laptop approx. 4 months apart. I called customer services & they told me that it has been the first they heard of it; but, when I spent over 2 hours calling the help service line after I updated and loaded the new software I was told that there were MANY calls regarding problems with the new software. Altho' it seems the desktops aren't affected by the upgrade. My iphone 4 isn't affected; in fact it runs the way my pod & laptop used to run before the upgrade...fast & efficiently!