Four Basic Principles That Underpin Construction Projects Economics Essay

Construction economics like pure economics, its mainstream equivalent is concerned with the allocation of scarce resources. This is far more complex that as it first appears. Many of the world’s resources (factors of production such as land, labour, capital and enterprise) are finite, yet people have infinite wants. We are therefore faced with a two-pronged problem; at any point in time there is a fixed stock of resources, set against many wants. In an attempt to reconcile this problem, economists argue that people must make careful choices, in terms in construction choices about what investments are made, how these are constructed and on whose behalf.

Construction is greatly dependent on the changes in the UK economy, and particularly on those which are the direct result of the government policy. Construction output is a response to the demand for buildings, and this is result of derived demand for other products and service. Variations in the Gross national product will, in this way, influence the demand for construction work and the associated level of employment.

There are four basic principles that underpin construction projects; supply, demand, markets and types of business.

Supply

The word supply used in economics is normally defined as; the total amount of good or service available for purchase; along with demand, one of the two key determinants of price. This definition states that supply can be calculated by looking at the demand.

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Supply can also be affected in many ways the main one being demand. However there can be other factors that can affect supply as well, it could be the price of other related goods for example; paper is made from trees, therefore a tree would be considered a related good to paper. If the price of harvesting a tree increases the supply for paper will decrease.

The line marked S is the supply curve. The curve depicts the relationship between two variables only; the price and quantity supplied. The supply curve can also shift left or right if there is an increase of supply for a certain product of service, it will increase the quantity and reduce the price.

A change in supply refers to a change in behaviour of sellers caused because a factor held constant has changed. As a result of a change in supply, there is a new relationship between price and quantity.

As the supply has changed or shifted to the right, we can see that the quantity has increased but the price has decreased.

Supply must always be looked at when beginning a construction project, for example if the supply of housing has decreased there would be no point in purchasing a house for refurbishment and selling it on as the demand would have also decreased. Therefore when beginning a project, the related supply should be checked carefully and the project should be started at the estimated time of equilibrium.

Demand

The word demand is used widely through out the economics world and it simply means; desire, a desire for someone to own a good or service also having the ability and willingness to pay.

Just like supply there are several factors that can affect demand the main one being supply. However there are other factors that can also affect demand this can be the price of related good or even income. The more income a person gets it is more likely that they will buy something. The preference of a certain good can also increase demand, for example if a large amount of people prefer a pair of jeans over a pair trouser then the demand for jeans will increase and the demand for a pair of trousers will decrease.

The red line shows the demand curve. The curve is two dimensional and depicts the relationship between two variables only; price and quantity demanded.

Looking at the diagram on the right, we can see the red demand curve, there is a shift to the right, this tells us that the demand has increased; therefore supply has increased along with the increase of price and quantity. For example, there would be a sudden demand for pancakes on Pancake Day, because of this the supply will increase, the price and quantity will also increase.

Elasticity of demand can be defined as, ‘the responsiveness of quantity demanded to a change in price’. (John Sloman, 2003, page44). If the price elasticity of a product is known then predications can be made on the effect of price and quantity for a supply curve. The size of change in supply and in demand can be calculated for comparison. It is measured in percentage.

This graph shows three constant-elasticity demand curves. D1 is a vertical curve; the quantity does not change if the price changes, therefore it has zero elasticity.

D2 is a horizontal curve; this is infinitely elastic. Any price below P0 gives an ‘infinite’ demand and any price above gives a demand of zero. The curve D3 if unitary elastic, this means when there is a given percentage change in the price of the good it will result in an identical percentage change in the quantity that is demanded.

In terms of a construction demand is very similar to supply, for example after completing refurbishment works on a house, it should not be sold immediately. It should be sold at a suitable time; it should be sold when the demand is high. The reason for this is, when the demand for housing is low the price of the house will decrease, and when the supply increases so does the price.

Markets

A command economy is where supply is controlled by the government, they decide what type of good and services are needed and decide how they are distributed.

A free market economy is all allocation of scares resources is determined by supply and demand. There is no control from the government, and there is free trade without any major problems.

A mixed economy has the best of both; there are parts of the command economy and parts of the free market economy, a mixed economy is an economic systems that allows for the simultaneous operation of publicly and privately owned enterprises.

Depending on the type of market there is a construction project can be affected in many ways. For example a command economy will just build houses if they are needed, they will sell house if they need to be sold, and there is little room for choice. A free market will build entirely out of will; if it is needed then it will be built. If someone has the desire and the correct funds to build a house, then they will. And if someone wishes to purchase a house, they will agree an amount and pay it off.

As above a mixed economy is the best of both, however in many circumstances the price for housing price does rise and fall. But, anyone person can build at their own will, but they will need planning permission.

Types of Business

There is a large extent of business structures they all have different purposes but all have the same goal to be successful. The types of business are; a sole traders, partnerships, public limited companies, private limited companies, housing associations, non-profit making organisations.

A sole trader is; an individual owns and runs their own business without the need for employees. For example this could be a small corner shop.

A partnership is; there are two or more people working together to make a profit. The partners together own the business and normally share out profits equally between each other. This could be a small/medium sized grocery store.

A public limited company (legally abbreviated to plc with or without full stops) is a type of limited liability Company in the United Kingdom and the Republic of Ireland (and other jurisdictions where companies’ law is derived from English law) which is permitted to offer its shares to the public. For example Natwest bank is a public limited company.

Housing Associations provide housing, they are more commonly known as Registered Social Landlords or RSL for short. They function as a normal business and any profits that may be made a put back into the business, so it is a non-profit making business. An example of a housing association is London and Quadrant housing trust.

Non-profit making organisations tend to help the local area or community and all surpluses are not distrusted but it is put back into the company to help it grow and achieve its goal.

When the recession hit the UK the supply and demand for housing were affected. Banks were not lending money for people who wanted to buy houses and many people were not interested in buying at all, as interest rate were too high. Therefore the demand for new housing dramatically decreased as a consequence the supply also decreased.

Scarcity

Scarcity is the fundamental economic problem of having seemingly unlimited human needs and wants, in a world of limited resources. It states that society has insufficient productive resources to fulfill all human wants and needs. [1] Certain goods are likely to remain inherently scarce by definition or by design; examples include land and positional goods such as awards generated by honor systems, fame, and membership of elites. These things are said to derive all or most of their value from their scarcity. This can be a large problem, many thing in the world are scarce this includes land, food, and other resources. For example land is a scarce resource as there is only a limited amount available, but it is always in demand. Also, scarcity can affect many things in construction for example raw materials are a scarce resource as it is always in high demand. Raw materials are sold in what is called the factor market. This is because raw materials are factors of production along with labour and capital. Raw materials are so important to the production process that the success of a country’s economy can be determined by the amount of natural resources the country has within its own borders. A country that has abundant natural resources does not need to import as many raw materials, and has an opportunity to export the materials to other countries. [2] Timber being a raw material, is a very scarce resource as the amount of time taken for it to grow is not quick enough for the ever growing human demand.

Task 2

The construction industry is heavily reliant on borrowing money to complete many projects. Many people can not afford to pay off a construction project completely. Hence, when the rescission hit the United Kingdom it had a large affect on it. Banks could not afford to lend any money that would go towards constriction projects; from this moment on the construction industry is still suffering as clients can not get hold of necessary funds to pay off the contractor.

Due to the downfall of the construction industry the housing industry has also declined as a result of this. ‘Office for National Statistics modelling suggests that the sector declined by 0.7 per cent in the first quarter of 2010, following the 0.9 per cent fall in the final quarter of 2009. UK GDP as a whole rose 0.2 per cent in the first quarter of 2010, the same data revealed. The weak data suggests that the brief growth period in mid-2009 was a false dawn as the construction sector has lagged behind ever since. Most predictions had suggested that 2010 would see further decline in construction, however, with many predicting falls of around 5 per cent this year to add to the double digit declines of 2009. While the reasons for the further contraction in the sector were unclear, some surveys have suggested there is lower spending in the public sector as projects are delayed in the run up to the election on 6 May. The rate of growth in the whole economy of 0.2 per cent is a slowdown from 0.4 per cent growth in the final quarter of 2009.’ [3] 

The UK government has plans for public spending and it is hoped that these will include major construction projects, such as roads, schools and other public buildings. This would help the construction industry and those companies that supply the construction industry to ensure continued employment for many.

‘Construction accounts for about 6 per cent of the economy, but analyst said that, despite its modest size, the rapid deterioration in the sector does not bode well for the economy, particularly following poor manufacturing figures last week.’ [4] 

Quite simply the main economic problem in construction is the fact that no one wants to build anything, because they can not build anything if they have no money. When a construction project commences the client needs to get a hold of enough funds to be able to complete the project.

Since the recession many construction projects have been put on hold, the reason for this is that bank were reluctant to give out any loan and any loan that they did give had very high interest rates, as a result of this many people were put off to even consider taking out a loan. Hence many people have been made redundant as companies could not afford to keep them employed. As more and more people became redundant, people became competitive, to try and fight for their job.

Only after the recession can work go back to normal, but it will take time for construction projects to go back how they were as construction projects are very expensive, and many of them are based on credit or loans given out by banks or other similar sources.

The term business cycle (or economic cycle) refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (expansion or boom), and periods of relative stagnation or decline (contraction or recession). These fluctuations are often measured using the growth rate of real gross domestic product. Despite being termed cycles, most of these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern. [5] 

Construction activity in the UK continued to decline in Q1 2009, but at a marginally slower pace than in Q4 2008. The net balance of surveyors reporting a decline in activity increased from -47 to -45. All sectors experienced declines in workloads, although such declines moderated in the private and, particularly, the public housing sectors. Private industrial and private commercial workloads continued to fall at pretty much the same rapid pace as in the previous quarter. Meanwhile, declines in infrastructure workloads accelerated and public non-housing workloads resumed their decline having increased in the previous quarter.

Private housing workloads continued to fall sharply Q1 2009, but a slower pace than in Q4 2008. Workloads fell at a slower pace in the South West, the Midlands/ East Anglia region, the North, Scotland and the London/ South East region. In Wales, workloads continued to fall at the same sharp pace as in the previous quarter. In Northern Ireland, private housing workloads fell at slower pace. Public housing workloads continued to fall, but only mildly. Workloads increased in the Midlands/ East Anglia region, they stabilised in Wales and they fell elsewhere. In Northern Ireland and Scotland, the pace of decline in public housing workloads picked up sharply. [6] 

Capital costs are costs incurred on the purchase of land, buildings, construction and equipment to be used in the production of goods or the rendering of services. In other words, the total cost needed to bring a project to a commercially operable status. However, capital costs are not limited to the initial construction of a factory or other business. For example, the purchase of a new machine that will increase production and last for years is a capital cost. Capital costs do not include labour costs except for the labour used for construction. Unlike operating costs, capital costs are one-time expenses, although payment may be spread out over many years [7] in financial reports and tax returns. Capital costs are fixed and are therefore independent of the level of output.