First let me explain how categories and tags work in general: Let’s say you decided you want to bake a batch of chocolate chip cookies. Your shopping list has eggs, flour, and milk. When you walk into the store, looking to pick up the ingredients, you don’t walk to aisle F for flour, but go to the baking aisle. You are going to the aisle based on a category, not the name of the ingredient. Categories are generally broad in scope, in that baking aisle not only can you find flour, but also sugar, spices, and chocolate chips.
Thanks to Twitter and Instagram, the term #hashtag is something you likely recognize, heck it’s even in the OED! If you leave out the actual hash sign, then you are left with the tag as it is most commonly used in blog posts today. Tags are generally more specific than categories; returning to my cookie analogy, cookies and chocolate chip cookies could be tags with baking as the category.
Categories and tags become sign posts within the website and help to organize it. These signs are most helpful for navigation, guiding site visitors deeper into the site, and also for search engine optimization. For navigation, it’s easy to provide a link to all the posts that have been assigned that term, for example, all my IT Literacy posts are set as that category.
Search engine optimization is a very complex (and often controversial) topic. Simply, with SEO you are trying to help the search engines figure out what the important topics and parts are of your site are and to display them when someone enters relevant search terms.
Organized content helps everyone, but keep it simple and logical for your site visitors!
Consistency is key for whatever categories and tags you choose to keep things organized. If you have a group of posts, for example, that are for cookies, then that should be the word you use. Cookie, cookies, chocolate chip cookies, and gluten-free chocolate chip cookies are all similar but different. How finely grained your categories and tags are depends on your site and what’s important to you. The categories and tags for a personal blog and a business blog, while covering similar topics, will likely be very different. When developing the site, this is something that needs to be thought about, though remember it can evolve over time. It’s important to design your site primarily for your visitors’ experience; a well designed site will not need to stress over SEO.
If you would like to learn more about SEO, Google developed an approachable Search Engine Optimization Starter Guide (pdf) and there is a brief introductory article from torque. For more about tags and categories, it is important to view documentation for your particular website, such as WordPress Categories vs. Tags and Blogger labels.