Types of Externalities:

1) Negative externality/ External cost/ External diseconomy

It occurs when the action of one party imposes costs on another party.

Example

a) Steel plant dumps its waste in a river that fishermen downstream depend on for their daily catch. The more waste the steel plant dumps in the river, the fewer fish it will support. Negative externality arises because the steel firm has no incentives to account for the external cost that it imposes on fishermen when making its production decision.

b) Pollution by a firm in the course of its production, which causes nuisance or harm to others, is an external cost of the society.

2) Positive Externality/ Beneficial externality/External economy

It occurs when the action of one party benefits another party. Some of the goods with positive externalities are known as merit goods.

Example

a) An individual planting an attractive garden in front of his house may benefit others living in the area. It is a positive externality to others.

b) Imparting education reduces crimes, unemployment, social-unrest, improves communications, strengthen democratic institutions etc. They are positive externalities (benefits) to the society as a whole. 

3) Network Externality

It occurs when the action of one party encourages another party to purchase the good or the general acceptance of such goods increases and therefore they are network externality.

Example: An individual buying a picture phone for the 1st  time will increase the usefulness and acceptance of such phones to people who want to call him or her.

4) Pecuniary externality

It arises from a particular action taken by an individual, which benefits him and makes other people worse off.

Example: A property tycoon buying up a large number of houses in a town, causing prices to rise and therefore making other people who want to buy houses worse off, perhaps by excluding them from the housing market.

5) Common property resources externality

It occurs when the action of one party betrays another to enjoy the benefits of the good by making them wore off.

 Example: Harvesting by one fishing company in the ocean depletes the stock of fish available for the other companies and over fishing may result into common property resources externality to other fishermen.

Externalities are important in economics because they may lead to economic inefficiency, as producers of externalities are not  bothered about their actions on others. Therefore, the need arises to reject the market prices of demand and supply as a source of economic inefficiency. Analyzing the external benefits and cost of externalities of private goods therefore becomes important.