When you first open iTunes 3, a dialog box appears with this message appears:
"iTunes has detected an existing iTunes folder in your Documents folder. Would you like to move this folder to your Music folder? This will not affect playback of your music in iTunes."
If you click Yes, iTunes will move the iTunes folder in your Documents folder to the Music folder in your Home directory. This includes all the music that you have encoded (as long as the iTunes Music folder is in the iTunes folder). iTunes doesn't copy the folders. It simply moves them. No extra disk space is required.
If you click No, iTunes will continue to work with the iTunes folder in your Documents folder.