External costs of electricity represent the monetary value of the environmental damage caused by electricity generation. Here they are calculated by use of the impact pathway method, which relates to a sequence of links between the environmental burden and its impact. Focus of this analysis has been put on the effects of ambient air pollution on human health, as one of the priority impacts of electricity generation. Quantitative relationships have been established linking air pollution with a number of health endpoints: premature mortality (acute and chronic), restricted activity days, and hospital admissions due to respiratory and cerebrovascular problems. The first part describes the steps of the impact pathway methodology, with an emphasis on atmospheric dispersion models as a crucial part to estimating health damages caused by polluted air. The aim of the analysis in the second part was to estimate costs of health damages through air pollution caused by electricity generation in Croatia. Two types of fossil-fired power plants are observed, one coal and one natural gas fired facility, those being among candidates for future power system expansion. Both facilities are assumed to be located in the densely populated urban area of Zagreb, the Croatian capital. Since air pollutants are transported over large distances crossing national borders, their impacts are quantified both on the local level, i.e. within 50 km from the source, as well as for Croatia and the whole of Europe. The largest share in the damage costs accounts for mortality effects attributable to particulate matter, on local level directly while on the regional level in the form of subsequently formed sulfates and nitrates. That is why the damages linked to coal power plants are much larger than those linked to gas fired facilities. Health damages highly depend on the number of people affected, so the local damages are much lower than on the regional scale. Although the calculated damage costs do not necessarily constitute externalities in their entirety, they can be used as good indicators of external costs. Cost benefit analysis of emission abatement technologies showed that strict SO2 and NOx emission standards in Europe are necessary so as to lower their very high impact caused by the large number of people affected. An attempt was made in the thesis to determine the optimal emission levels of SO2 and NOx by equating the marginal damage costs with the marginal abatement costs. The results were in the range of the current emission standards, which is a very good match. That example and some more presented in the thesis prove that external costs can be quite reliable and useful tool in designing environment protection policy.