A broad term in economic theory which denotes any good or service whose allocation is not or cannot be controlled effectively by price systems. Externalities are measured as a balance between the cost to the individual producer or consumer of the good or service and the cost to society as a whole.
A negative externality is one where the costs to society is higher than the cost to the producer. A textbook example of this is clean air. Air is free; there is no effective way to charge for (clean) air, so factories and automobile drivers do not hesitate to pollute it in the absence of emissions controls and guidelines.
A positive externality, conversely, is one where the benefits to society are higher than the benefits to the producer, i.e.: the producer does not reap the full economic benefit of producing the good. Examples include: research, education, public gardens. A positive externality is sometimes called a public good.
Externalities are the basis of the theoretical justification for much government legislation. Negative externalities are addressed with fines, taxes and permits, and sometimes by creating credits for the externality that can be traded in a market. Positive externalities are addressed with grants and subsidies.