Externalities are spill-over effects from production and consumption that are not compensated for through market transactions. They can be positive or negative and cause market failure if social costs and benefits are not accounted for. Private costs and benefits differ from social costs and benefits due to externalities. For example, with negative externalities, social costs exceed private costs, leading to overproduction. Economists value externalities using methods like shadow pricing and willingness to pay. Governments consider net social benefits when deciding between projects to maximize returns to society.