The images should all be converted to .jpg or .gif format. It's a good rule of thumb to avoid spaces and special characters in file names in general, and especially so for images for the web. Try to keep file names short but descriptive.
Collect all your images, whether photos, scans, or downloads, into a single folder on the desktop, or in the documents folder, and drag them into iPhoto. If you are using PhotoStory, you can drag the images directly into the first window of your project.
Be sure to use relatively high resolution images, at least 300 dpi for a scan; if you are searching on the internet, limit the search to images with 300 or more pixels in each dimension. The video will have a pixelated look if you use lower resolution images. "Larger than 640 X 480" is an even better choice, but may limit the search results too much.
You can set up these criteria in Google's Advanced Image Search:
To search free images under creative commons, you can visit the following websites:
http://search.creativecommons.org/
http://www.flickr.com/creativecommons/
http://www.calisphere.universityofcalifornia.edu/