Externalities are costs or benefits that affect third parties who are not directly involved in an economic transaction. For example, when a factory pollutes the air, nearby residents suffer health issues, which is a negative externality. Conversely, if a homeowner plants a beautiful garden, neighbors may enjoy the view, creating a positive externality. These external effects can lead to market failures, as the true costs or benefits are not reflected in the prices of goods and services. To address externalities, governments may implement regulations or taxes, such as a carbon tax, to encourage businesses to reduce harmful impacts on society.