How can externalities be a limitation of using Gross Domestic Product as an index of welfare?

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Solution

Increase in Gross Domestic Product is due to increased economic activities like industrialisation and urbanisation. With increased industrialisation, certain problems for society also increase like pollution of air, water and soil and deforestation. Urbanisation also results in housing problems, increase in road accidents, etc. On the whole, welfare decreases and this decrease in welfare is ignored while calculation of GDP. So, we can say that externalities can be a limitation of using GDP as an index of welfare.

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