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When you install a project for the first time and you don’t specify a version number, i.e. pysetup install spam, the latest version (or the latest final version (non-alpha/beta/rc), Alexis knows better) should be installed. This could be added to the docs.
If you later run "pysetup install "spam (X.Y)"" where X.Y is a higher version than what’s installed, then the project should be upgraded, unless it breaks other project’s dependencies (i.e. ham depends on spam < X.Y). There aren’t probably any tests for this.
If you have a version of spam installed and want to upgrade to the latest version that still satisfies other installed projects’ dependencies, without having to give a version number, (your request IIUC), then you could use a trick like "pysetup install "spam (< 99.99)"" (untested). However, I agree that "pysetup install --upgrade spam" is a better UI: it’s less kludgy and already familiar to pip and easy_install users.