AVI, which stands for Audio Video Interleave, is a Container format used by Microsoft's Video for Windows multimedia framework. Since it was developed for Windows 3.1 in 1992 it lacks some features found in newer containers like MPEG or MP4, but is still widely used by consumers and even supported by some standalone DVD players. Although still supported in Windows, and suitable for certain formats like DV, it's not a good general purpose container, and even Microsoft uses other containers for their own video formats.
In order for Windows to play an AVI file its necessary to know what decoder on your computer should be used to render the video. AVI files all have a property called a FourCC, which consists of four letters, based on what kind of encoding is used. VfW decoders then register particular FourCCs with Windows, letting it know that they can Decode video in those formats. Some FourCCs correspond to a single application, meaning only one Codec can be used for decoding. Others, like DVSC for DV or any of the standard MPEG-4 FourCCs, can be decoded by a variety of VfW decoders that conform to those standards. The FourCC of a file can be changed with a tool called AVI FourCC Changer.
When video enthusiasts began tinkering with MPEG-4 ASP encoding they found that it was possible to store the video in the already deprecated AVI container. Although later on an official MPEG-4 container (MP4) was developed, compatibility with existing tools and VfW codecs has remained popular for MPEG-4 ASP encoding with such codecs as DivX, XviD, and 3ivX.
DVD Player Support
In 2003 the Kiss DP-450 DVD player was introduced to the public. It was the first standalone DVD player capable of MPEG-4 playback. In the years since a number of other manufacturers, including more mainstream companies like Onkyo, Panasonic, and Pioneer, have began selling such DVD players. Although supported features of different MPEG-4 codecs varies somewhat, one common feature is the ability to read AVI files.
Since DV doesn't have an official container of its own most Windows software designed for working with it assumes the AVI container will be used. DV files stored in the AVI container may be of two different types - Type 1 and Type 2.
Type 1 DV
Type 1 DV files are technically not VfW compatible because the video and audio inside must be split into separate streams by DirectShow software, normally implemented in DirectShow. While this affects VfW based tools like VirtualDub, it can be solved by using AviSynth, which is capable of using DirectShow to open files. Type 1 files can also be converted (losslessly) to Type 2 in order to open with standard VfW applications. The format used to mux the video and audio in a Type 1 file is the same as what's used when a camcorder stores it to DV tape.
Type 2 DV
Type 2 DV files can be opened in the same way as other AVI files, meaning you need to have a VfW DV codec installed on your system. While Microsoft provides a DirectShow decoder for Type 1 files, you must use a third party decoder of some kind for Type 2 files.
AVI files can be created with no Compression, resulting in extremely large file sizes, but with no loss of quality from the input video to the saved file. This also requires no codecs to be installed, either for saving or playback. This is generally not recommended. Instead it's better to use a Lossless Compression format like Huffyuv.
If you want to create a smaller AVI than you can get with no compression, but with the highest quality possible, you can also use a lossless codec like HuffYUV or Lagaraith. The files will still be significantly larger than standard compressed files, but good for use as intermediary files for editing and then compressing later.