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Thanks to Craig Buchek and GodfreyNix for the content of this page.
The basic notion of a file on a computer is an analogy with real-world files. A file generally contains information on a single subject matter.
Most computer systems have files and directories which contain files. Many systems call the directories "folders", which are places where files can be kept. One system (AmigaOS) calls them drawers instead, with icons looking like file cabinets.
One place where the folder analogy breaks down is that on a computer, folders can contain folders which in turn can also contain other folders, and so on. In the real world, you generally would not be able to put a folder inside a folder inside a folder.
That is why the term 'directory' is better. Just as a phone directory or trade directory list all the numbers collected by name, trade, district and so on. A computer directory 'holds' all the files on a related topic - so all your text files in a directory called 'text', all photos in a directory called 'pictures' and so on. Just as in a phone book you might find an entry in the wrong section, so you might with computer directories. That is why the search button is so useful. Think also of a brochure listing holiday homes available for hire. An advert may be for a house, or it may be advertising another brochure (which contains adverts for homes and adverts for brochures, which contain ... you see the point?)