Externalities are the good and bad impact of an activity without paying the price or penalty for that. Example of a positive externality is when a beautiful garden maintained by Mr. X raises welfare of Mr. Y even when Mr. Y is not paying for it.
Impact of externalities is not accounted in the index of welfare in terms of GDP. To that extent , GDP as an index of welfare is an inappropriate index .It either Underestimates or overestimates the level of welfare.
