GDP as an index of welfare may understate or overstate welfare. explain the statement using examples of positive and negative externality.

Dear student,

Externalities occur when a party which is not voluntary involved in consumption or production of a good is affected by the activity. 
Positive externality lead GDP to understate welfare. For example: when free drinking water facilities are given by local government to an area, everyone get benefit out of it.
Negative Externality lead GDP to overstate welfare. For example: When one setup a factory in residential area, it create pollution in nearby area and trouble people residing there.



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