When you install an application from the Android market or from else where it will tell you the permission(s) it needs to function. While some legitimate applications often ask for more permissions than they need, it should at least raise some concern when deciding if an application is safe and of good quality.
To see permission(s) of a given application after installation, go to the Market, press menu > My apps, then select the application, press menu > more, then press security. There is an application called ‘permissions‘ to help explain the permissions of the applications you have installed on your smartphone.
Below is a list that was initially prepared by Lost Packet who talks about android security in much greater detail.