Economic Analysis: Funding incentives encourage awarding higher grades

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Perhaps the best bumper sticker for economics is: Incentives matter. This insight is vital in thinking about behavior, including how for-profit and not-for-profit firms operate. Here is an example from our own backyard.

From 1970 to 1990, university completion rates, defined as the percentage of entering university freshmen who attain a degree within six years, declined. However, since 1990, the trend has reversed, and completion rates have increased. Our friend Kevin Mumford at Purdue University and several colleagues recently published a paper in the American Economic Journal: Applied Economics titled: “Why have college completion rates increased?” They concluded the most likely reason is grade inflation. In other words, colleges and universities now give higher grades for the same quality of student work than they did in the early 1990s.

They estimate that “changes in first-year GPA account for 95% of the change in graduation rates.” In one data set, freshmen students “had lower pre-collegiate math percentiles … (but) (d)espite this decline in preparation, first-year college GPA increased from 2.44 to 2.65.” They also report, “The first-year GPA for all students increases from 2.68 to 2.79.” Students are getting higher grades while working more hours at paid jobs and studying fewer hours for their classes. At one school that had given the same test over many years, students were getting lower test scores while being awarded higher grades.

What explains this relaxed grading? Incentives! The authors note that, since the 1990s, “the number of state policies that tie appropriations for higher education to college completion via performance-based funding mechanisms has increased. … Increased attention to graduation and performance-based funding gives schools an incentive to increase graduation rates.” They conclude: “Why did grade point averages increase from the 1990s to 2010? One likely candidate is the recent policy focus on college completion rates. … Changing standards for degree receipt is a low-cost way to increase graduation rates.”

Some might support higher grades for the same work because it helps more students graduate faster. On the other hand, others might feel that lower standards means more students are graduating without the skills a college degree is supposed to signal—to the long-run detriment of the economy and society.

We’ll keep our focus on the effect of incentives and let the reader decide whether those effects are positive or negative for the students, employers and the economy. We look forward to additional research and insights on the topic.•


Bohanon and Horowitz are professors of economics at Ball State University. Send comments to

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