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Question

What are externalities? Give an example of a positive externality and its impact on the welfare of the people.


Solution

Externalities refer to the benefits or harms of an activity caused by a firm or an individual for which they are not paid or penalized. Activities resulting in benefits to others are called positive externalities.

Example: Construction of a flyover or a highway reduces transport cost and journey time of its users. Expenditure on construction is included in GDP but not the positive externalities which increase welfare. This implies that welfare is much more than indicated by GDP.

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