Well, to start with your drive will need replacing if you want to continue to use this system. The blinking folder with a question mark implies the drive has problems. But, before we go there you do have to think through what your plans are here.
This system is quite limited. The highest OS you can run on it is OS-X Lion (10.7). The max RAM it can support is 4 GB. The Hard drives SATA I/O is SATA I (1.5 Gb/s) which limits you on what will work as a replacement drive.
If you are just planing on using this system for basic web surfing or writing you should be fine. But most apps available today won't run on this older system. Some web sites won't respond as they use newer standards your system can't deal with. You'll also need to be careful as Apple has long since stopped offering OS updates and you do run the risk of malware.
Replacement CD: Lion CD
The best replacement drive: Seagate Desktop SSHD. This is one of the few 3.5" drives which offer auto SATA speed sense Spec sheet. So it will work in your systems slower SATA I (1.5 Gb's) interface. I wouldn't go crazy here, a 1 TB drive will be just fine.
Lastly, heres the IFIXIT guide to replace the drive: iMac Intel 17" Hard Drive Replacement