1. How are college-grades determined? The economics literature points towards a simple answer: "by spending more time on study". I don't provide links here, but for evidence on the positive relationship between study-time and grades, see Arulampalam, Naylor and Smith (2007), Stinebrickner and Stinebrickner (2007) and Martins and Walker (2006). Dustmann and Van Soest (2007) show that part-time employment while in school has a negative effect on males' exam performance. Kalenkoski and Pabilonia (2010), DeSimone (2008), Joensen (2007), Oettinger (2005), Van Dyke et al. (2005), Stinebrickner and Stinebrickner (2003) and Ehrenberg (1987) all provide evidence that working (to varying degrees) while in college has a harmful effect on grades.
2. Why do students care about their grades? Again, I don't provide links here, but for evidence on the positive relationship between college grades and subsequent earnings, see McIntosh (2006), Loury and Garman (1995), Jones and Jackson (1990), Filer (1983) and Wise (1975).
3. What about grade inflation? Some economists are concerned about its interaction with the signalling model of labour market earnings. Others extend this concern to how social background may end up as a driver of labour market sorting.
4. However, grade inflation is hard to measure. In the paper 'More For Less or Less for More?', Geraint Johnes (Lancaster) and Robert McNabb (Cardiff) emphasise that studies of grade inflation have not distinguished between the effects of declining standards and increasing efficiency. "Yet both of these phenomena can plausibly explain an improvement in measured performance of educational institutions over time." Johnes and McNabb propose a method whereby competing effects can be disentangled. Their findings suggest that there has been no decline in standards in the UK university sector during the last decade. Efficiency, meanwhile, has risen steadily over the last 25 years.
5. It is also worth bearing in mind that sometimes universities split into high-grading and low-grading departments. Sabit and Wakeman-Linn (Journal of Economic Perspectives, albeit as far back as 1991) discuss the situation in the United States: "Economics, along with Chemistry and Math, tends to be low-grading. Art, English, Philosophy, Psychology and Political Science tends to be high-grading." Interestingly, it appears that there are higher returns to more harshly marked disciplines; see "Ability Sorting and the Returns to College Major" (Arcidiacono, Journal of Econometrics, 2003). "Large monetary premiums exist for choosing natural science and business majors even after controlling for selection."