This chapter introduces the readers to externalities and their applications to the real world. After reading this chapter and working on the practice questions, the learners should be able to understand what externalities are and how their presence can distort market outcomes; recognize real-world examples of external costs and benefits; distinguish between market and efficient equilibrium; explain why externalities are sources of market failure; construct graphs to demonstrate how corrective taxes and subsidies can be used to solve the externalities problem; propose various solutions to the externalities problem; and distinguish between four types of goods based on their excludability and rivalry properties.