Libertarian, maximum personal liberty. If you were a libertarian, you wouldn't care about the cheating. Let the little bastards screw themselves.
Libertarian doctrine (such as it is) says nothing about incentives.
Getting worked up about the cheating, you assume society (or at least your class room) should be merit-based. Pretty much the opposite of libertarianism.
A clever teacher would figure out a way for students to police each other. I've seen it work to great effect. No one grades harder than a peer.
Edit: I was being a dick, comment about whining removed.