The Photoshop color overlay effect is a technique used in image editing to apply a semi-transparent color over an image. It is commonly used to change the mood, enhance the colors, or create artistic effects. In Photoshop, this can be achieved by selecting the 'Layer' menu, choosing 'New Adjustment Layer', and then selecting 'Color Overlay'. Users can adjust the color, opacity, blending mode, and other settings to achieve the desired effect.