[I originally posted this to vox.com on 13 Apr 2008.]
Huh? It's as simple as that?
To get LyX to generate PDF files with fonts that look good on both paper and screen, just delete the "TeX encoding" field value on the Tools / Preferences... / Outputs / LaTeX dialog. This applies at least to LyX 1.5.4.
As initially installed, that field contains the value "T1". My understanding is, that value provides better international compatibility. T1 encoding causes LyX to embed only Type 3 (bitmapped) fonts in PDF files. You can verify this by checking the embedded fonts section of the document properties in the generated PDF files.
If you only plan to write in English, you most likely don't need T1 encoding.
The problem is that bitmapped fonts don't scale (grow and shrink) well. Type 1 fonts, however, are "outline" fonts, which are scalable to any size. If you delete the "TeX encoding" field value, LyX will embed Type 1 fonts into the PDF output, and your documents will look great.
I can't account for the nomenclature: Why does the "T1" value generate "Type 3" fonts instead of "Type 1" fonts? It's counterintuitive, isn't it?
I also can't account for why the LyX installer doesn't explain this and offer to adjust it at install-time. It offers to set the default paper size to US Letter, and the default language to English. It sure would have saved me a lot of time and aggravation if it would explain the situation and offer to null out the default TeX encoding.