I suspect it would be much nicer for both the dev and the users if there was just a single "Upgrade to the latest version for $5" option. Don't try to splinter the upgrade path into features or sub-steps. So, as a consumer story: you buy v3 for $10. Over the next year, v4,5,6 come out and you pass on them. V7 finally convinces you to upgrade and you shell out $5 to go from 3->7 with a single click. Meanwhile, if you were a power-user, you might have been impatient and shelled out $5 each for v4,5,6 along the way. But, I think that's a pretty reasonable way do perform price discrimination.
If a developer is going to offer a version upgrade, it's the fact of a previous version purchase that signifies eligibility. The app store clearly has this purchase information. So why not give the developer the option to set previous versions to act as "coupons" reducing the price of the new version by a developer specified amount? When version 5 is released at $20, let old versions be set so they can no longer be purchased anew. Let the developer set owners of version 4 as seeing the price of version 5 as $10. If you own version 3, then perhaps 5 is $15. Let previous versions themselves be upgrade coupons.
In-app purchases are left as orthogonal to these upgrades. The developer could perhaps be allowed to continue to push out bug fixes for older versions, or even old version DLC.
