Moved to the Dreamweaver Application Development forum, which deals with PHP and other server-side things.
You're also confused about the difference between absolute and relative links. An absolute link is a fully qualified link - it contains the full path. Links that begin with ../ and / are both relative links. The first style is relative to the document. The second is relative to the site root.
When using PHP includes, the path to the include file must either be relative to the document or the file must be in the PHP include_path.
When using links inside an include file, they should normally be relative to the site root.
The reason your links are not working locally is because the site root is localhost. You are probably developing your site in a subfolder of localhost. Consequently, the links are pointing to one folder above what you want.
The solution is to create a virtual host. The gory details on setting up virtual hosts in Windows can be found in this tutorial on my site: http://foundationphp.com/tutorials/apache22_vhosts.php.