Cheap Encoder

This simple 16 step encoder can be built from radioshack parts.
http://www.radioshack.com/product/index.jsp?productId=2049723

It might be possible to get more steps from the encoder using something like http://www.thingiverse.com/thing:1527 .

Modified this circuit to fit the radio shack parts: http://www.pyroelectro.com/tutorials/simple_motor_encoder/theory.html If you skip ahead a few pages it tells you one way to implement it on a microcontroller too.