I've worked with a lot of mostly college-age students over the years, and I've discovered a couple things in recent times:
1) They are downloading music constantly and not buying many CDs anymore. When I ask them about this, they act all sheepish and say that they plan to purchase a CD copy of things that they like, but I know that most of the time this isn't happening. I don't let them burn my CDs, but I know they just go elsewhere and seldom pay much if anything, and most of the time it's not because they're broke. The other big problem I've noticed is that, because they are downloading, they aren't getting all of the info about the recording (personnel, dates etc.) and therefore aren't learning as much from their listening as they should. An important point of learning to listen is to be able to recognize specific players and their stylistic nuances. There certainly are resources to obtain this information, but I usually have to hound them to do it. The better students are pretty good about this, but many of the mid-level students really don't seem to "get it".
2) They tend not to appreciate things as much when they're free. For me, this applies also to private lessons taught outside of my school load- students pay attention and prepare much better when they are paying for a lesson. I used to frequently teach for free, thinking I was providing a service, but I found that there was much less progress and it ended up frequently as a waste of time for all involved. I do, however, still give free lessons on occasion when I know the student is broke but genuinely interested, or a potential student is visiting campus.
As far as free music downloading, I agree with Paul that this is leading to an overall decline in interest.