Configuration parameter work_mem in PostgreSQL on Linux

I posted your query plan on explain.depesz.com, have a look.

The query planner's estimates are terribly wrong in some places. Have you run ANALYZE recently?

Read the chapters in the manual on Statistics Used by the Planner and Planner Cost Constants. Pay special attention to the chapters on random_page_cost and default_statistics_target.
You might try:

ALTER TABLE diplomas ALTER COLUMN number SET STATISTICS 1000;
ANALYZE diplomas;

Or go even a higher for a table with 10M rows. It depends on data distribution and actual queries. Experiment. Default is 100, maximum is 10000.

For a database of that size, only 1 or 5 MB of work_mem are generally not enough. Read the Postgres Wiki page on Tuning Postgres that @aleroot linked to.

As your query needs 430104kB of memory on disk according to EXPLAIN output, you have to set work_mem to something like 500MB or more to allow in-memory sorting. In-memory representation of data needs some more space than on-disk representation. You may be interested in what Tom Lane posted on that matter recently.

Increasing work_mem by just a little, like you tried, won't help much or can even slow down. Setting it to high globally can even hurt, especially with concurrent access. Multiple sessions might starve one another for resources. Allocating more for one purpose takes away memory from another if the resource is limited. The best setup depends on the complete situation.

To avoid side effects, only set it high enough locally in your session, and temporarily for the query:

SET work_mem = '500MB';

Reset it to your default afterwards:

RESET work_mem;

Or use SET LOCAL to set it just for the current transaction to begin with.

SET search_path='tmp';
-- Generate some data ...
-- DROP table tmp.table_name ;
-- CREATE table tmp.table_name ( n INTEGER NOT NULL PRIMARY KEY);
-- INSERT INTO tmp.table_name(n) SELECT generate_series(1,1000);
-- DELETE FROM tmp.table_name WHERE random() < 0.05 ;

The except query is equivalent to the following NOT EXISTS form, which generates a different query plan (but the same results) here ( 9.0.1beta something)

-- EXPLAIN ANALYZE
WITH q1 AS (
    SELECT 1+tn.n  AS n
    FROM table_name tn
    WHERE NOT EXISTS (
        SELECT * FROM table_name nx
        WHERE nx.n = tn.n+1
        )   
    )
SELECT q1.n
FROM q1
ORDER BY q1.n DESC;

(a version with a recursive CTE might also be possible :-)

EDIT: the query plans. all for 100K records with 0.2 % deleted

Original query:

    ------------------------------------------------------------------------------------------------------------------------------------------
 Sort  (cost=36461.76..36711.20 rows=99778 width=4) (actual time=2682.600..2682.917 rows=222 loops=1)
   Sort Key: q1.n
   Sort Method:  quicksort  Memory: 22kB
   ->  Subquery Scan q1  (cost=24984.41..26979.97 rows=99778 width=4) (actual time=2003.047..2682.036 rows=222 loops=1)
         ->  SetOp Except  (cost=24984.41..25982.19 rows=99778 width=4) (actual time=2003.042..2681.389 rows=222 loops=1)
               ->  Sort  (cost=24984.41..25483.30 rows=199556 width=4) (actual time=2002.584..2368.963 rows=199556 loops=1)
                     Sort Key: "*SELECT* 1".n
                     Sort Method:  external merge  Disk: 3512kB
                     ->  Append  (cost=0.00..5026.57 rows=199556 width=4) (actual time=0.071..1452.838 rows=199556 loops=1)
                           ->  Subquery Scan "*SELECT* 1"  (cost=0.00..2638.01 rows=99778 width=4) (actual time=0.067..470.652 rows=99778 loops=1)
                                 ->  Seq Scan on table_name  (cost=0.00..1640.22 rows=99778 width=4) (actual time=0.063..178.365 rows=99778 loops=1)
                           ->  Subquery Scan "*SELECT* 2"  (cost=0.00..2388.56 rows=99778 width=4) (actual time=0.014..429.224 rows=99778 loops=1)
                                 ->  Seq Scan on table_name  (cost=0.00..1390.78 rows=99778 width=4) (actual time=0.011..143.320 rows=99778 loops=1)
 Total runtime: 2684.840 ms
(14 rows)

NOT EXISTS-version with CTE:

----------------------------------------------------------------------------------------------------------------------
 Sort  (cost=6394.60..6394.60 rows=1 width=4) (actual time=699.190..699.498 rows=222 loops=1)
   Sort Key: q1.n
   Sort Method:  quicksort  Memory: 22kB
   CTE q1
     ->  Hash Anti Join  (cost=2980.01..6394.57 rows=1 width=4) (actual time=312.262..697.985 rows=222 loops=1)
           Hash Cond: ((tn.n + 1) = nx.n)
           ->  Seq Scan on table_name tn  (cost=0.00..1390.78 rows=99778 width=4) (actual time=0.013..143.210 rows=99778 loops=1)
           ->  Hash  (cost=1390.78..1390.78 rows=99778 width=4) (actual time=309.923..309.923 rows=99778 loops=1)
                 ->  Seq Scan on table_name nx  (cost=0.00..1390.78 rows=99778 width=4) (actual time=0.007..144.102 rows=99778 loops=1)
   ->  CTE Scan on q1  (cost=0.00..0.02 rows=1 width=4) (actual time=312.270..698.742 rows=222 loops=1)
 Total runtime: 700.040 ms
(11 rows)

NOT EXISTS-version without CTE

--------------------------------------------------------------------------------------------------------------------------------------
 Sort  (cost=6394.58..6394.58 rows=1 width=4) (actual time=692.313..692.625 rows=222 loops=1)
   Sort Key: ((1 + tn.n))
   Sort Method:  quicksort  Memory: 22kB
   ->  Hash Anti Join  (cost=2980.01..6394.57 rows=1 width=4) (actual time=308.046..691.849 rows=222 loops=1)
         Hash Cond: ((tn.n + 1) = nx.n)
         ->  Seq Scan on table_name tn  (cost=0.00..1390.78 rows=99778 width=4) (actual time=0.014..142.781 rows=99778 loops=1)
         ->  Hash  (cost=1390.78..1390.78 rows=99778 width=4) (actual time=305.732..305.732 rows=99778 loops=1)
               ->  Seq Scan on table_name nx  (cost=0.00..1390.78 rows=99778 width=4) (actual time=0.007..143.783 rows=99778 loops=1)
 Total runtime: 693.139 ms
(9 rows)

My conclusion is that the "NOT EXISTS" versions cause postgres to produce better plans.