I recently read this interesting article regarding grade inflation, grade compression, and Princeton's attempts at a solution.
There are really three broad reasons to go to college ("because someone told me to" does not count as a reason): Consumption, Productivity, and Signaling. For a more detailed discussion of the first two, feel free to attend my first lecture next semester. When we're talking about grade inflation / compression, the concern is the third reason.
The basic idea is that there are better workers and worse workers. Better workers should have better jobs, more responsibilities, higher pay, etc. The problem is that worse workers also want better jobs with higher pay, and it is very difficult for a potential employer to know which type the person they are interviewing really is. Under this problem (which economists call hidden information or adverse selection), better workers will never be offered what their skill and productivity deserves.
One possible way around this problem is for workers to be able to send a signal: better workers need to do something that could only pay off for them if they are the better type; something that would never be worth while for a worker who will always be low productivity. One option is to get a college degree. Better workers endure years of expense, pain, and frustration at never-ending busywork in order to prove they are someone who can endure years of expense, pain, and frustration at never-ending busywork. The end result is for the best workers to be identified as having endured the best, the next best enduring next best, and so on. This helps potential employers identify worker types, and thus reward them appropriately.
This only works if workers are able to properly differentiate between types of workers who come through the signaling process. From this perspective, the purpose of posting letter from the beginning of the alphabet next to students' class records is to separate them into different types. Some schools will even add +/- to the letter in order to provide further differentiation. Historically, most students coming through the system would receive a C, better students would receive a B, and the very best would receive A (F was typically for the people who probably shouldn't be trying to signal their type). In order for this separation to work, there must be many labels available for different student types.
Which brings us to the problem of grade inflation. Now, for those of you who know any macroeconomics, you will already know that in the long run inflation doesn't cause problems by itself (it's only in the short run when not everything is inflating at the same rate that problems arise). However, inflation is really on the proper term if there is no maximum level being approached. In the case of grades, though, we just don't have anywhere to go above A+ or 100%. As most students move from C to B to B+, the available degrees of differentiation get fewer and fewer. This reduces the pain and pressure students feel to perform, which is certainly more enjoyable for them. However, it also makes it harder for better workers to distinguish themselves, and therefore less likely that they will be paid what they're worth when they leave school: not so nice for them.
Because of this, my averages are always in the C range. I don't impose this directly on each class, since that would make it hard to separate students from different classes. But I don't dumb down the material, grant special bonuses, or curve up, either. In general, I've found that a plurality of students always put in just enough time/effort/skill to get in the 70-79% range, so that's what they earn. Across my university, something in the range of 30% of students in intro level courses get A's these days. In the Economics department, it's about half that, mostly because our department chair takes a firm stand against grade inflation. The proportion of A's I give out is on the low end even for our department; on the other hand, I can and have written some extremely glowing recommendations for my A students before, pointing out the fact that making an A in my course is a big deal.
This earned me the title of "the mean TA" a few years ago. I guess I am kinda mean about it. In the long run, though, I think resisting grade inflation is much more in the interest of the students than being "nice" and taking away their ability to signal.
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