Lecture 2 - Coconstruction Economicsnstruction Economics

CONSTRUCTI
ON
ECONOMICS
Business Economics & Finance Management - CIT
Construction Economics
Construction economics is a part (branch) of

general economics & studies the techniques of
economics applied by construction firms, the
construction business & the construction industry
Construction activity has existed ever since the

days of the cave man, & exists everywhere
wherever there are human settlements.
Per Capita construction costs vary widely according

to the per capita income of the region, from as low
as $ 5 per head per annum in Ethiopia, to $ 5000
in Japan. In India, yearly expenditure on
construction activity is $ 52 per head
Characteristics of construction industry
1. Physical nature of the final product which are

durable buildings & works and therefore large bulky
& expensive and are demanded over a wide
geographical area.
2. There are inputs ( which are intermediate
products by themselves, eg cables) which are small,
or bulky (steel, cement) and are manufactured
elsewhere. The inter-relation amongst these products
regarding price & production (inputs) often define the
nature of the construction industry.
3. Work is discontinuous across sites. Amongst clients,

Govt is one of the major ones. Construction firms,
Contractors & consultants all have fixed offices out of
which they cater to the work going on at the sites.
The role of the Govt as employer of construction
workers,
is
steadily
diminishing,
while
subcontracting of labour is a steadily increasing
practice, not only in India but across the World.
The quality of labour required is not highly skilled, &
consequently labour contractors source labour at a

cheap rates. Suppliers of inputs have to correspond
with the consultant / contractors at their offices
regarding tendering & supply directly at the work
site.
Demand for construction industry depends

on the ultimate use of the product:
whether it is a consumer good used by the end
consumer (housing)
Whether it is a intermediate good used as a means
for further production ( factories)
Whether is a social good used for the betterment of
the society at large (hospitals)
Whether it is an infrastructure good used for the
overall development of the economy (roads)
The govt has traditionally been responsible for

more than half the demand of construction
goods, though its share of demand has been
falling since the early nineties
Construction Sector & the Economy
Construction goods are capital goods, they are

demanded not for their own sake but for what they can
produce (exception housing)
Products of construction are expensive, their value is

high wrt the income of purchasers
( people take loans
to purchase them)
Construction goods have a long life, & small fluctuations

in supply & demand has a big impact on prices
The govt is a major client esp for infrastructure products,

more so in developing nations like India where
Infrastructure development is the key to economic
development
Construction Sector works as regulator of economy
Construction at any project follows a predictable

pattern, slow in the beginning, picks up speed & trails off
at the end.
Demand & timing for construction (for e.g a factory)

depends on the demand for the final good the factory will
produce, and not solely on the cost of constructing the
factory.
Postponement or cancellation of any construction project

produces disruptions to not only the project concerned,
but can be also felt distinctly outside the direct chain, eg
steel and cement suppliers will face a glut; carpenters,
electricians will suddenly be out of work, etc
Fluctuations in demand in output of construction industry,

depends on the category of construction demand:
New projects A new Airport, a new Housing Building. These
opportunities are large for developing countries like India

New Investments for extensions to existing units this depends
upon the state of the economy

Replacement of existing units in a new form changing a tar road
into a concrete road

Rehabilitation & improvement of existing units
Repair & Maintenance
Demand for private housing
Data has shown that the price elasticity of demand

for housing (for personal use) is inelastic in nature
Demand for private housing has increased with tax

relief measures and lowered interest rates for
housing loans
Income elasticity for luxury housing is elastic in

nature, and demand increases during boom periods
In India, the current housing shortfall is 10.8 million units.
It is estimated that Rs.1 crore in housing

generate 750 man years of employment;
A 10% increase in final expenditure in construction,

increases GDP by 3%, and yields 15 lac new jobs, ie, 9%
new construction jobs.
The fiscal multiplier for expenditure in construction is 5,

ie, a 1 unit fiscal expenditure in construction increases
GDP by 5 units
will
Demand for Industrial & Commercial

Construction
Demand for factories & offices is dependent not on the

users of the factories of the buildings, but on the
ultimate consumer of the products & services
manufactured at these buildings. This is known as
derived demand
The Acceleration Principle: Whenever the demand

for any good increases, the capital goods required to
produce the good increases in turn, which includes
commercial buildings. Eg whenever the demand for
steel increases, the demand for construction of steel
plants increases
Since demand is derived, demand is more affected by

profitability than price.
Demand for Social Construction & Infrastructure
Deals with construction of hospitals, roads, schools etc, which

the community (society) enjoy but are not ready to pay for
directly
The public sector has traditionally been a major client for

social sector construction projects, though of late private
sector participation has come in through BOT, BOLT, BOOT etc
Cost benefit analysis like NPV(Net Pressure Value) and

IRR(Internal Rate of Return) and welfare economics
techniques are applied to gauge the demand
The demand for infrastructure often depends on the future

increases in their need & is constrained by budgets & prices.
The process of the construction

industry
Clients the initiators of the process, may by Govt

or non Govt
Developers who may be Builders or the Main

Contractors, - they determine the price of the
construction work
They engage Sub Contractors, & Consultants in

the form of principal designers, consulting civil
engineers,
architects,
quantity
surveyors,
designers etc. Material Suppliers supply materials,
Labour Contractors supply labourers.
Construction Costs
The costs of a construction process, are not regular,

they are low at the outset of the project, rise to a
peak and decline, even if we assume that the project
is completed at a steady pace.
Variable costs include materials & components which

comprises 50% of the total cost of construction, site
labour which comprises of 33% of the total cost of
construction, apart from site management costs, site
plant & equipment cost (owned or hired).
The contractor needs to keep working capital for site

work as low as possible, & cost of estimation as low
as possible.Fixed Costs are a smaller proportion &
include
head
office
expenses,
interests, etc
Business
Economics
& Finance Management
- CIT
Construction
77% of the global construction activity is concentrated in

Developed countries & the balance 23% in developing
countries.
Within the developed countries, Europe contributes for 30%

of global construction output, USA for 21%, & Japan for 20%
Within the developing countries, China contributes for 6%

of global construction output, & India for 1.7%
In the richer countries, where labour is expensive,

machines have replaced men in many construction jobs
while in poorer countries, where labour is cheaper, manual
methods are used
Construction
As far as employment goes, the developed

countries employ only 26% of the total
construction workforce, while the balance 74% is
employed in the developing countries; thereby
the developing countries employ 80 million of the
total workforce in excess of 111 million
construction workers
Per capita construction output in low income

countries is $ 8507 compared to $79623 in richer
countries
Labor-intensive & Capital intensive
Labor-intensive: requiring a large expenditure of

labor but not much capital
Capital intensiveis the term for the amount of

fixed or real capital(capital)present in relation
to
other
factors
of
production,(
factors of production) especially labor.
At the level of either a production process or the
aggregate economy, it may be estimated by the

capital/labor ratio
Capital incentive:
Industry requiring large sums of investment in

purchase, maintenance, and payback of capital
equipment-such as automative, petroleum & steel
industry.
Capital intensive industries need a high volume of

production and a high margin of profit (as well as
low interest rates) to be able to provide adequate
RETURNS ON INVESTMENT. (As in labor intensive.)
Labour intensive vs Capital intensive

construction
The use of capital intensive techniques makes

economic sense in rich short-of-labour countries
Often a bias is created towards modern capital

intensive techniques, by clients, consultants &
lenders in construction
In countries with low wage rates & high

unemployment rates, replacement of labour by
capital does not make economic or social sense
unless necessitated by tender specs, unless there
are time over runs or quality problems
India doesnt need Mass Production instead India needs
Production by Masses - Ghandhi

Construction in India
Developing countries including India have

witnessed a spurt of construction activity in the
last 30 years, In India the construction sector,
currently comprising for 5% of the GDP, is growing
at 8.4% per annum.
The construction sector employs the highest

number of people after agriculture & it is the most
employment elastic industry in the country. It is
predicted to employ 32.6 million people by 200506, of which just the housing sector alone will
employ around 20 million workers
With the cost per job created being the lowest

across sectors, construction is called the
employment spinning sector
The construction sector in India is a dichotomous

one (In 2 ways) with a mixture modern capital
intensive methods with traditional labour
intensive ones
The Indian construction business is the 12 th

largest in the world, with a business volume of
Rs.2,30,000 crores, producing1.7% of the global
output at an investment of $52 per capita
16% of Indias working population depend on

the construction industry, directly or indirectly
There is an increase in the use of casual labour

& subcontracted labour, mostly migrant labour
who move from site to site
Though paid wages higher than manual

workers, a shortage in skills in workers has
been observed since there is no proper training
& large contractors are thinking on lines of
investment on manpower training
Indian Construction the changing

face
Due to increase in outsourcing of labour through

subcontractors, the role of large construction
companies has gradually changed from physical
construction to consultancy, management &
coordination, and a step forward to finding clients
& marketing of products, which are in turn
produced by subcontractors.
The top firms have moved to international

markets through mergers & acquisitions

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CONSTRUCTI

Business Economics & Finance Management - CIT

Construction economics is a part (branch) of

Construction activity has existed ever since the

Per Capita construction costs vary widely according

Characteristics of construction industry

1. Physical nature of the final product which are

3. Work is discontinuous across sites. Amongst clients,

The quality of labour required is not highly skilled, &

consequently labour contractors source labour at a

Demand for construction industry depends

The govt has traditionally been responsible for

Construction Sector & the Economy

Construction goods are capital goods, they are

Products of construction are expensive, their value is

Construction goods have a long life, & small fluctuations

The govt is a major client esp for infrastructure products,

Construction Sector & the Economy

Construction Sector works as regulator of economy

Construction at any project follows a predictable

Demand & timing for construction (for e.g a factory)

Postponement or cancellation of any construction project

Construction Sector & the Economy

Fluctuations in demand in output of construction industry,

opportunities are large for developing countries like India

upon the state of the economy

into a concrete road

Demand for private housing

Data has shown that the price elasticity of demand

Demand for private housing has increased with tax

Income elasticity for luxury housing is elastic in

Business Economics & Finance Management - CIT

In India, the current housing shortfall is 10.8 million units.

It is estimated that Rs.1 crore in housing

A 10% increase in final expenditure in construction,

The fiscal multiplier for expenditure in construction is 5,

Business Economics & Finance Management - CIT

Demand for Industrial & Commercial

Demand for factories & offices is dependent not on the

The Acceleration Principle: Whenever the demand

Since demand is derived, demand is more affected by

Demand for Social Construction & Infrastructure

Deals with construction of hospitals, roads, schools etc, which

The public sector has traditionally been a major client for

Cost benefit analysis like NPV(Net Pressure Value) and

The demand for infrastructure often depends on the future

The process of the construction

Clients the initiators of the process, may by Govt

Developers who may be Builders or the Main

They engage Sub Contractors, & Consultants in

Business Economics & Finance Management - CIT

The costs of a construction process, are not regular,

Variable costs include materials & components which

The contractor needs to keep working capital for site

77% of the global construction activity is concentrated in

Within the developed countries, Europe contributes for 30%

Within the developing countries, China contributes for 6%

In the richer countries, where labour is expensive,

As far as employment goes, the developed

Per capita construction output in low income

Business Economics & Finance Management - CIT

Labor-intensive & Capital intensive