What are Externalities?

When deeds of one economic agent causes some costs for other economic agents which is not borne by that economic agent then there occurs negative externality. However, when action of an economic agent causes benefits for others for which no payment is received then there is occurrence of positive externality and ‘externality’ refers to both positive and negative externality or external benefits or costs and in the presence of any externality, competitive market fails.
There is a critical attribute of externalities is that there exist products that individuals want but are not sold. For example:- there does not exist any market for gliding smoke from cigars.
Each and every interaction between buyers and seller takes place through market and hence, all the individuals in an economy should know about consumption or production possibility. Basically, externalities do not lead to Pareto efficient allocations.