Images are treated as character-level markup in HTML, which means that they may appear anywhere simple text can appear, such as: in-line text, in headings, even in links (typically as buttons). Because they appear much like text, there is a problem to consider - how does text flow around an image? How does a browser know the size of an image?
There are 2 main image types on the web, Graphics Interchange Format (GIF), invented by Compuserve, and Joint Photographics Expert Group (JPEG). A newer format, Portable Network Graphics (PNG), will probably become popular now that it is supported in Netscape Navigator 4.0 and Internet Explorer 5.0 without plug-ins.
I will not be covering the advantage and disadvantages of each of these format, nor how to make image files - that is a topic for a whole class by itself. A few things must be mentioned, however. JPEG should be used for photographic material with many shades of color, and GIF should be used for small cartoons and bullets. GIFs are limited in that they may contain only 256 different colors, but GIF images may be merged in a sequence called an 'animated GIF'. GIF may also contain a transparent color, which means that the background browser canvas shows through. PNG files share some of the best features of both formats and include the ability to account for some of the differences in the various display monitors of computer systems.