Can I use an External Hard Drive To Store my Media and Link to Applications (iTunes, iPhoto)?

Good Afternoon,
I purchased a Macbook Air as a hold over until I could get a Macbook Pro.  Unfortunately some things have come up and I am going to have to wait a little longer than anticipated before buying the Macbook Pro.  Since I initially intended to have this laptop only for a short time I got the bare bones one with the 128 GB SSD.
Is there a way to set things up so I can move all of my media ( Music, Movies, Pictures etc,, ) onto a external portable hard drive that I can connect to the the laptop before I boot it up and have applications ( iTunes, iPhote etc. ) automatically link to the hard drive and my media?
I called Apple to see what the cost would be, if it was even possible, to have the 128 GB replaced with a 256 GB and I was told that it is possible, but it not a service they offer.  So he suggested that I do this instead.
I know this is something that is fairly easy to do on a PC as I have done it before, but my concern is if Apple applications would work.  I always had the understanding that iTunes ( for example ) must have its files stored to the local drive.
Any help is appreciated.
Thanks,
Eric

I have multiple iTunes libraries on the system now.  I have one for my iPhone ( I left that one called iTunes ), I have one for my Nano that I use when I run ( Called iPod Nano ), and I have one called AppleTV that holds my movies.  I switch between them regularly, so I understand switching between libraries.
So it basically does not matter where the library is located ( Local Drive or External ), as long as the proper library is selected when the external is connected?

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