Figured it out. If the entry is not in the php.ini file which in our Ubuntu installation it is under: /etc/php5/apache2/php.ini, then you have to enter it manually simply adding the line
; added 2012-Feb. 22 gradebook issue
max_input_vars = [something above 1000]
of course the first line above is a comment. Got the solution from here: http://dev.tcea.org/index.php/moodle-tips-mainmenu-35/139-have-recent-problem-with-gradebook-display