It's a technically easy way to create product differentiation and start capturing consumer surplus. It's also easy for their salespeople to explain the added value to a wide audience - "you can take more pictures and video, and run more apps on this version." Easy to do and easy to sell is a product manager's dream.

Production cost is irrelevant. People don't buy things based on how much they cost to make. It's all about value, and Apple knows how to sell it. I would be interested to see a breakdown of how much of Apple's profits have come from selling Flash upgrades. I'm sure it has proven to be a brilliant pricing strategy earning them untold billions.