Externalities means positive (good) and negative (bad) impact of any economic activity and no one receives any payment for them and no one is penalised for it. For example if Mr. X maintain a beautiful garden which is used by neighbourers then it give pleasure and welfare to all of them but no one is paying for it, then it will be an example of positive externalities. It is not included in GDP. So in such cases actual welfare of the economy is more than what GDP reflects means GDP represents underestimation of welfare of the economy.
