Saving photos in iPhoto

Is there a way to set iPhoto to save downloaded photos to an external hard drive? I looked under "Preferences" but didn't see any mention. Are we stuck with having our photos saved in the iPhoto Library on our computer's HD?

Pretty much, yes. Unless you move the library, but it's not recommended.
You can of course back the photo's up by dragging and dropping from the iPhoto window to a folder on an external drive.

The developers need have this option in their next version of iPhoto. It's surprising they would omit this feature.

You can do File-Export according to your preferences too…not perfect but it's something.

Are you asking if you can simply have all of your photos on an external and use them in iPhoto from there? If so, this is what you want: iPhoto 8.0 Help: Moving your iPhoto Library folder to a new location

If you move your library to an external, and then select that external by holding down the option key when you open iPhoto, you will be working with your photos on the external and you will free up space on your internal (if you delete the library from your internal). Newly downloaded photos will automatically go onto the external as well. That selection will remain the default until and unless you change it back to the internal. Is this what you are looking for?