What's an MPEG-2 File?
MPEG stands for Moving Picture Experts Group, formed in 1988 to develop standards to put videos on discs. Their MPEG-1 standard was designed to make video CDs (VCDs). The desire for bigger, better video files on discs led to the MPEG-2 standard finalized in 1995, and the roll-out of DVDs. We know how much DVDs have captured the hearts and wallets of those who watch movies at home. The format was and continues to be hugely successful.
MPEG-2 files were made for disc distribution and local playing, not for consumer editing. But we want to do it anyways.
The spread of MPEG-2 didn't stop with professionally produced DVDs... today you find them on many camcorders, those that record on min-DVDs and many of the hard drive models. Also, capture devices that record from TV often make MPEG-2 files. Topping those off are personal computers with their DVD burners and DVD making software. Consumers want, and have, lots of MPEG-2 files, and they want to use clips from them in their movie projects.
Note that MPEG-2 files can come with various file extensions such as: .mpeg, .mpg, .mod, .vob. To compound that, file extensions are hidden by default so you may not be seeing them. If you're getting the error message, you're using an MPEG-2 file.
So why the error?
To understand the error message we need to look a little deeper into the file type. MPEG-2 files are more highly compressed then DV-AVI files.