Externalities are a type of market failure that occurs when the costs or benefits of a good sold in a market are not entirely paid or received by the market participants. When this happens, the market fails to produce the best outcome for society. That is, the market fails to be efficient in the sense that total economic surplus is not maximized.
externalities occur when someone other than the buyer or seller of a good incurs a
cost when that good is produced or consumed. Many forms of pollution can
be classified as generating negative externalities. If the pollution is unregulated (i.e. there is no government intervention into the market), then the market that produces the pollution is inefficient.
When visualizing negative externalities from pollution, students often think of a factory emitting harmful substances from a smokestack, or an industrial agricultural facility creating water pollution from pesticide runoff. That is, we tend to conceptualize pollution externalities as the result of production (the supply side of the market), and place blame on "big corporations".
But we must keep in mind that as consumers we are largely responsible for pollution impacts, because if we didn't demand those goods and services, they would not be produced. Here is a link to a story at EurekAlert regarding pollution from consumption. The main takeaway is that consumers are mostly responsible for pollution, albeit indirectly. Which country's citizens have the biggest impact via consumption? Which products that you consume every day generate the most pollution?
When we speak of "external costs", what types of costs are we talking about? The first thing that comes to mind for me is loss of human health. Here is a story about the health effects of air pollution. The numbers are staggering.
I'm often asked to comment on the idea that environmental regulations make the economy less productive. My reaction is typically that it's exactly the opposite. There is a vast amount of evidence suggesting that reducing air and water pollution can make the economy more productive, not less.
Here is an article at The Atlantic outline the healthcare costs savings of the Clean Air Act.
Here is a good description of the benefits of clean water from David Brodwin at US News.
Here is a brief outline of negative externalities associated with air pollution from transportation from Hofstra University.
Here is some good background reading on negative externalities and public goods from the IMF.