Should I increase the memory in my iMac?

To determine if you can benefit from more RAM, launch Activity Monitor and click the System Memory tab at the bottom to check your page outs. Page outs are cumulative since your last restart, so the best way to check is to restart your computer and track page outs under your normal workload (the apps, browser pages and documents you normally would have open). If your page outs are significant (say 1GB or more) under normal use, you may benefit from more RAM. If your page outs are zero or very low during normal use, you probably won't see any performance improvement from adding RAM.

Mac OS X: Reading system memory usage in Activity Monitor

 

Honestly, from your description you should check the health of your HDD.

 

Memory is cheap and your iMac can handle up to 6GB RAM. It won't slow down your system
I would upgrade it, I love the 12GB RAM in my iMac^^
But if you want a faster Mac, you have to get a SSD.

 

Like dude above said, check activity monitor to see if you're capping out (which you almost definitely are). But an easy test ia if you often see th beach ball thingy you prolly need RAM.

 

I will tell you exactly what you can do

in order
1)if you have money, upgrade to latest imac

2)either
upgrade memory to max(4 gig max)

http://support.apple.com/kb/HT1593

OR

SSD

BUT, w/ such older model(which means all the interface is old and maxing out at 4gig of memory is really not that great jump).
Bottom line? save up and get a either new imac or build a pc. It's time to get a new machine.