Raffles has given a nice summary. All I would add it that I prefer to reference all links in relation to the root folder (Raffles' last example) as the reference is always the same no matter what page you are on. E.g.
Code:
.foo {
background-image:url(/img/bar.gif);
}

Originally Posted by
EvanGR
And how does that affecting when developing locally and for the server?
The only downside with this method is that it only works on the server, not on your desktop--unless you are running your own server environment or using something like WAMP or MAMP.
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