After the merge, file1 contains both the changes from file2 to file1 and the changes from file2 to file3. In other words, file1 keeps its changes and incorporates the changes in file3 as well. merge does not change file2 or file3.
If a line from file2 was changed in different ways in both file1 and file3, merge recognizes a conflict. By default, the command outputs a warning and puts brackets around the conflict, with lines preceded by <<<<<<< and >>>>>>>. A typical conflict looks like this:
<<<<<<< file1 relevant lines from file1 ======= relevant lines from file3 >>>>>>> file3
If there are conflicts, the user should edit the result and delete one of the alternatives