An optical encoder measures how far something has moved, optically. It does this by looking at a pattern of alternating black-and-white, and counting number of transitions.
http://www.swiss.ai.mit.edu/~pmitros/encoder/
A simple and inexpensive method of constructing a robust optical encoder capable of producing quadrature encoded signals.
http://users.on.net/~merrifield/opto/index.html
http://users.rcn.com/carlott/projects.html
Building and understanding it you will test your knowledge about interfacing to an encoder, counting, and driving a display to show the information.
http://www.nutchip.com/progetti/encoder_display_en.htm
http://www.nutchip.com/progetti/encoder_led_en.htm
http://www.schematicsforfree.com/misc_circuits/A-D_Encoder-Logarithmic.pdf