Inserting image into IPython notebook markdown
Most of the answers given so far go in the wrong direction, suggesting to load additional libraries and use the code instead of markup. In Ipython/Jupyter Notebooks it is very simple. Make sure the cell is indeed in markup and to display a image use:
Further advantage compared to the other methods proposed is that you can display all common file formats including jpg, png, and gif (animations).
I am using ipython 2.0, so just two line.
from IPython.display import Image
Image(filename='output1.png')
Files inside the notebook dir are available under a "files/" url. So if it's in the base path, it would be <img src="files/image.png">, and subdirs etc. are also available: <img src="files/subdir/image.png">, etc.
Update: starting with IPython 2.0, the files/ prefix is no longer needed (cf. release notes). So now the solution <img src="image.png"> simply works as expected.