Answer by Balaji Viswanathan:
This is called Psychological pricing and has been studied a lot by the marketers. http://en.wikipedia.org/wiki/Psychological_pricing
The concept was not invented by "Bata" as one of the other answers suggested, but has been in existence far before that – at least since 1880s. Here is a 130 year old ad .
Although the top answer claims a definitive history, the answer to the origin of this strategy is unclear.  There are 3 different theories of its history:
- Marketers (such as RH Macy) of mid 1800s tried to ambush their competitors in highly price sensitive goods.
- Melville Stone of Chicago Daily News priced his paper at 1 cent. However, given that cents were not in common use then, he coaxed local shops into odd pricing so that his customers will have the pennies to spend on his paper.
- Assuggested, it was a cash control mechanism due to the arrival of the cash register.
Why do they continue to do odd pricing?
- Customers see odd numbers as correctly priced rather than whole numbers. They tend to think that a rational process is involved in the pricing and go with the pricing. On the other hand, with whole pricing, some customers perceive that they are being gouged.
- Odd pricing also sends a psychological cue that the good is priced to the lowest possible.
- In the earlier days, competitors in commodity products tried to gain more market share by pricing a penny or two lower than their competitors.
- Various researches indicate that customers are swayed more by the most significant first digits of a price tag and sometimes by the last digit. In one research done in 1997 they found that 90% of the prices end with either 9 or 5. However, as customers are subconsciously getting used to these odd prices, other companies like Wal-mart favor more of pricing ending with .98 to stay out of the crowd.