First make sure the video system can read your source video file by scrolling through the movie in the TealMovie Encoder preview screen, which is also used for scaling or cropping the source video.
If it can't display the movie properly in the preview, you likely need to (re)install the proper 16-bit video codec needed by your AVI file.
The TealMovie Encoder (MakeMovie) uses the Microsoft Video for Windows (VFW) decompression services to read AVI files. VFW uses 16-bit codecs, which are different from the 32-bit codecs used by Windows Media Player.
Try using GSpot (gspot.headbands.com) to analyze the AVI file and show you the compression type used and codecs you currently have installed (under View->Installed Codecs->Video). If you don't have a 16-bit VFW codec installed that matches the compression type used by the AVI file, perform an online search to find and download any missing codecs you may need.
Another useful app is VirtualDub (freeware), available at www.virtualdub.org. VirtualDub can often read damaged AVI files that Video for Windows has problems with. Try opening the file, and then saving out a new uncompressed AVI. If VirualDub cannot open the file either, there is most likely a problem with codecs.