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Additional internal drives have a role, but with external hard drives being cheap and common, adding storage to your system can be very quick and easy.
I have a 80 GB hard disk in my system. I'd like to upgrade the storage capacity. Which is a better option: getting an external hard disk or internal hard disk?
It depends on how you use the machine, how comfortable you are installing hardware, and how much effort you want to go through.
Let's add "replace the existing hard drive" to the mix, and review all three options.
Add an External Drive
Adding an external USB (or Firewire/1394) drive is by far the easiest approach. Purchase the drive, set it up, plug it in, and you've instantly increased your storage capacity by however large a drive you purchased. It's a perfect solution for many needs.
The biggest downside to this approach is speed.
USB 2.0 is rated to 480 Mbps - that's (approximately) 480 million bits per second. That sounds fast (and it certainly is much faster than USB 1.1's 12 Mbps), but it's slower than the transfer rates afforded by the hard disks themselves. A good average transfer rate from a hard disk these days is 700 Mbps, or nearly twice as fast as that data could be transferred over a USB interface.
That USB 2.0 480 Mbps is also a theoretical maximum, and can quickly be degraded by the activity of other USB devices connected to the machine. (Firewire/1394 connections suffer this same complication, but benefit from there not being as many Firewire devices. In addition, some Firewire interfaces can support a maximum of 800Mbps, and thus may be able to keep up with typical hard disk transfer rates.)
Other "complications" of a USB drive are the additional power and connection cables required, the fact that it's an additional box to be placed near your computer, and the fact that the drive will appear as an additional drive letter on your machine. These aren't big problems at all, but worth noting.
Overall, if your needs are not typically disk speed intensive, an external hard drive is often the simplest solution.
In the coming months, external drives may take on additional appeal as ESATA and USB 3 interfaces become more common. These interfaces support transfer rates that are actually faster then the typical hard disk drive, and thus should presumably make external drives as fast as the alternatives.
Add an Internal Drive
Installing an additional drive into your machine is the best way to get the maximum performance out of a new drive. It also removes the whole problem of having an additional external box that you need to plug in somewhere.
You'll need to make sure that your computer has room for an additional drive, and that the computer's power supply is sufficiently powerful to handle the extra load.
The biggest issue is simply one of installation: you need to be comfortable opening up your machine and following the drive (or computer) manufacturer's instructions for installing the internal drive.
Or you may choose to have a technician do it for you.
Replace your Internal Drive
If you want that drive to be internal, but your computer doesn't have room for an additional internal drive (perhaps it's a laptop), or you just want your C: drive to remain as is, only bigger, the only practical alternative is to replace it. The complication here is that you'll need to move your data from one drive to the other as part of the replacement.
The typical sequence is to create a full system image backup, replace the hard drive, and then restore that image backup to the new drive. While that sounds simple, you'll need to make sure that your backup and restore software can handle restoring to a different sized drive, and that it has a way to restore to "bare metal", meaning a machine that has an empty hard drive with no operating system to boot into.
And once again, this scenario also requires that you be comfortable opening up your computer and fiddling around with the internals.
Bottom line: for most people unless you have special requirements an external drive is a fine solution. It's quick, easy and provides a much needed increase in capacity. The bonus is that you can move it to another computer just as quickly and easily as you installed it at first.
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