First, yes having insuficient real memory can slow the machine down.
The less real memory that you have, the more time Windows needs to spend transfering data back and forth from the paging (swap) file.
As to where all of your memory is being used, you can install any number of memory utilities taht let you see what is using what portion of your memory.
Check out www.completelyfreesoftware.com for free utilities.
I suspect that a lot of what is using up your memory is virtual device drivers.
Oh, does the HP have on-board video, or a seperate video card?
If it has on board video, that is where your memory resources are going. It would be fairly easy to show the video using up 1/2 of your RAM.
XP does not have the memory limitations of W9X. So it wouldn't hurt to add another 256MB DIMM to the system. More memory is still the cheapest system upgrade.
Chas