Constructing Costs

The economic analysis of creating contracts is surely an unexplored field within Law and Economics. This document makes an effort to throw some light over the subject and inspire to more research within the field. The key objective has been to summarize why the actual price in a public construction project usually happens to be higher than the contract price and provides a way to handle that risk. In the report a model is established which exhibits an optimal contract given expectations on actual price and gaps in contracts. Cost increases for the buyer can primarily be described by two situations. The very first situation is when something unanticipated happens that forces costs to elevate for the project as a whole and the risk is already allocated beforehand. If the contract specifies that the buyer should bear the current risk it won’t cause any procedural problems and the project will end up more costly for the buyer. The 2nd situation originates when a risk is realised and the contract hasn’t specified how to approach it. Bargaining power and anticipations alternatively parts behaviour will be of importance to how to place the extra costs. A more general dialogue is also held about contract forms in the construction sector and the way that different contracts handle financial risk. One conclusion is that a fixed price contract with no gaps probably is the ideal method for the government to keep control of price increases. Regrettably, in real life almost all contracts suffer from gaps. The document proves that cost plus contracts ought to be used very rarely primarily because of the low incentives it gives the contractor to keep costs down.

Contents: Constructing Costs

1 Introduction
1.1 Background to the Problem
1.2 Purpose
1.3 Method
1.4 Delimitation
2 Empirical Cases
2.1 About the Empirical Research
2.2 The Hospital of Sunderby
2.3 Eksjö Library
2.4 Vallsundsbron
2.5 Co-ordinated Location of the Garrison in Eksjö
2.6 Zenithuset
2.7 The South Highway Entrance to Helsingborg
2.8 Moderna Museet
2.9 Concluding Remarks on the Empirical Research
3 The Construction Sector and the Risks
3.1 General
3.2 Contract Forms in Construction Sector and the Financial Risk
3.2.1 Cost Plus Contracts
3.2.2 Target Cost Contracts
3.2.3 Measure and Value Contracts
3.2.4 Contracts Based on Drawings and Specification
3.2.5 Package Deal Contracts
3.2.6 Comparison Between the Contracts in Construction Sector
3.3 Ground Condition Risk
3.4 Legal and Procedural Risk
3.5 Designing and Construction Risk
4 The Model
4.1 The Model in General
4.2 Contractor’s Profit
4.3 Government’s Outlay Minimisation
4.4 The Interaction Between Government and Contractor
4.5 The Impact of Risk Aversion in the Model
5 Conclusions
5.1 Concluding Remarks
5.2 Final Remarks

Source: Linköping University

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