The correct way to phrase this question is "Capture Lossy or Lossless Image?" When the question is asked by using the correct terms, the answer is readily apparent. It's just easier to communicate using "JPEG" and "TIFF" for many folks. So in this article, "JPEG" stands for all lossy formats, while "TIFF" stands for all lossless formats (like BMP, PNG, and RAW).
I have described the lossy and lossless image format concept in the "Hacking Digital Cameras" book. Due to the licensing contract with the publisher, I won't reprint or rewrite it in this article. If you have a copy of "Hacking Digital Cameras", you might consider referring to "Chapter 3 - Accessing Raw Sensor Data" while reading this article.
People ask me this question a lot. The question is not always easy to answer. Many times people just wanted to be comforted that that they have made the right choice. They just wanted to hear that it is okay to capture in JPEG format. They don't want to hear that they are missing out. So when I see that there is no way to convince a person to shoot TIFF, I just relax and say, "For your propose, shooting JPEG is probably fine". For those people, I even go as far as making up a few faux reasons, such as "Your camera could store JPEG faster than TIFF." There are plenty of other faux reasons just like it, such as "Your family will probably never see the JPEG artifacts on a 4x6!" So if you really want to be comforted, I can make you very comfortable at shooting in JPEG format.
However, since you are at the Camera Hacker web site, you are probably exploring and really want to learn about photography. Therefore I am going to set the record straight for you. Yes! You are absolutely missing out by shooting JPEG. It is absolutely the wrong format to shoot your originals in. That is, unless your camera doesn't support any other format. In which case, you probably won't ask this question.
The problem with JPEG, and its lossy characteristic, is that it forms compression artifacts in your image. Many people call it JPEG artifacts. The JPEG compression algorithm works by taking advantage of human visual limitations and throwing away image data which people have a hard time seeing. The end result is a very fast compression algorithm that generates very small photographic image files. The drawback is that you loose some image data and it creates distortions in your images, called artifacts.
JPEG2000 supports lossless mode. However, I am not aware of any digital camera nor any photo editing software that support this mode. In addition, one of the related links below provides a straight-forward description of it: "The lossless mode attempts to obviate formats such as PNG, JPEG-LS, GIF and others - but with a large computational overhead and no mentionable improvement in compression results." Therefore, JPEG2000 lossless mode is not referenced in the context of this article.
My personal experience shows that no matter how good your camera is or how many megapixel your camera has, JPEG images contain compression artifacts. I have framed four 16"x20" photographs in my living room. Two of them are shot at 3 MP in RAW mode. One is shot at 5 MP in JPEG mode. The fourth is originally shot on negative film and is scanned. At normal viewing distance, the print made from the JPEG original looks great! However, at two feet, you start seeing that the 16"x20" print is more than meets the eyes. So you move 1 foot closer and the JPEG compression artifact is readily apparent to your eyes. There are no compression artifacts in any of the other three prints.
Full disclosure: The 3 MP RAW originals are shot with the Canon EOS D30 digital SLR camera. The JPEG original is shot with Sony Cyber-shot DSC-P92 digital camera in fine mode. The negative original is shot with Canon EOS Elan IIe and scanned with Acer film scanner. All of the originals are post-processed in an image editing software and are saved in JPEG format at the lowest compression setting. The files are electronically transferred to Shutterfly, which has made the 16"x20" prints. The files are transferred and printed in the same batch order.
Although the final electronic images were sent to the printer in JPEG format, there were no visible compression artifacts in the lowest JPEG compression mode. The point is not that JPEG could be a viable imaging format with little or zero compression artifacts, but rather, you shouldn't trust your digital camera to produce a low compression JPEG original. Of all the digital cameras I know about, none of them produces JPEG images at the lowest compression setting.
Having said all that, the bottom line is to shoot in TIFF mode. You never know when you might want to do anything with your images where image quality is important, such as blowing it up to 16"x20".
This article is similar to the "Shoot in RAW, Always!" article I wrote a while back. Although the conclusions are the same and both articles are technically related, they approach the problem through two entirely different practical experiences. That article is available elsewhere on this site.
Yesterday (2006-08-27), only three days after writing this article, I was sitting in one of the consultation room at the City of Hope National Medical Center. The room exhibits an 11"x14" photograph of the water lily. The photograph is excellently framed, composed, and exposed. It looks beautiful. So I approached it for a closer appreciation. At about two feet away, the water lily flower pops out of the frame; almost 3D like. But yet, something is not right. The edge between the water lily flower and the background looks artificial. Perhaps this artwork is a well-executed painting rather than photograph. I move even closer for a thorough study. Nope, it's a photograph all right. In fact, it's a JPEG photograph print.
The compression artifact from the JPEG is even worse than from my 16"x20" print. In fact, the water lily flower petals have lost all of their texture details. Only thing left on the flower petals are pixels left over from the JPEG compression. The photograph is probably shot in JPEG mode, either in high compression mode or shot with a resolution that is lower than today's standards. It's a pity that such a beautiful image is captured with sub-par image quality.