In modern browsers, you can simply drag and drop images from the local filesystem or from a browser window to your diagram as follows:

 

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Image Quality and Size

Large images are resampled. Use Ctrl+Drag to show a dialog for the image size if the dialog does not appear automatically. (Note: Images are resized because large images are slowing down the client, especially the autosave functionality, and are counting against your realtime file size limit in Google Drive. Try using a link to an image for large images instead.)


Chrome App

Note: Drag and drop for images in the Chrome app is not supported due to security restrictions. Use File, Import to add images there.