The Foxes put up a brave fight against League 2 opposition at Prenton Park, but the senior side proved too strong in the end.
Lining up in a fluid 3-4-1-2 formation, Thanawat Suengchitthawon played in behind the front two, supporting Jake Wakeling and Ali Reghba.
The hosts made a perfect start, as Morgan Ferrier used his strength to move into the box and strike a low shot underneath Jakub Stolarczyk.
Leicester had not played a competitive fixture since facing Arsenal Under-23s on 18 December and Tranmere looked to take advantage as Jay Spearing rifled in a fierce effort that Stolarczyk did well to parry away.
City's ventures forward were few and far between in the opening stages, and when Sidnei Tavares got into the area, he was unable to get a shot away.
However, Leicester did get their first attempt soon after as Ali Reghba worked himself a shooting opportunity on the edge of the area but dragged the effort wide of goal.
Tranmere continued to threaten themselves when Corey Blackett-Taylor weaved his way into the area and saw his shot held by Stolarczyk, who got down quickly to claim the ball.
Blackett-Taylor went for goal with another powerful effort that was headed clear by Darragh O'Connor, before Paul Lewis flicked the ball on for Blackett-Taylor, but this time couldn't find the target from an acute angle.
Leicester rallied before the break and levelled the tie via Jake Wakeling's superb first-time finish, beating Joe Murphy at his near post.
Tranmere immediately re-established their advantage, however, when Ferrier crossed for Danny Lloyd to head in from close range.
And another fabulous save from Stolarczyk pushed Ferrier's sweet strike over the crossbar moments later as Rovers looked to assert their dominance before the break.
Back at the other end, Shane Flynn's corner had to be punched away right on the goal-line by Murphy, before Callum Hulme saw a powerful shot blocked and Callum Wright's effort on the rebound was cleared.
In a carbon copy of their second goal and coming just after Leicester had threatened, Tranmere doubled their advantage. Ferrier crossed for Lloyd to convert inside the six-yard box, right on the stroke of half-time.
Leicester started the second half on the front foot as Wright drove forward and was invited to shoot, his effort was heading for goal until being deflected wide.
Once again the home side were able to make the Foxes pay courtesy of Blackett-Taylor's tidy finish.
City soon got the second goal their play deserved when Suengchitthawon scored his second in this season's competition, striking from range to hand the visitors a lifeline.
And they went close to a third through substitute Dempsey Arlott-John and then Wakeling, who flicked Flynn's cross wide of target.
Back at the other end, Otis Khan forced a fine stop out of Stolarczyk as the game entered the final 10 minutes. It became more stretched with Leicester searching for goals, but when they failed to find a way through, Stolarczyk had to be alert to keep out substitute Kaiyne Woolery twice in the closing stages.
Jake Wakeling had put City back on level terms at Prenton Park.
Had one of the Leicester efforts created just before Tranmere's third goal gone in, the tie would have looked very different at the break. But as it was, Tranmere were more clinical in front of net and their lead proved unassailable despite a second-half fightback from the Foxes.
The Foxes 'keeper made a string of impressive stops during the tie.
Despite the scoreline, Jakub Stolarczyk made several fine saves, particularly in the first half, which on another day could have made the difference.
Where does it leave us?
Leicester City's Development Squad
The Foxes beat three senior teams to reach this stage of the tournament.
City exit the The Papa John’s Trophy at the third round stage having progressed through the group stage and beaten Salford City in the first knockout round.
City turn their attention back to league action on Monday, at home to Manchester United.
City's Development Squad are back in Premier League 2 Division 1 action on Monday evening, hosting Manchester United Under-23s at Seagrave (7pm GMT kick-off).
City: Stolarczyk; Daley-Campbell, O'Connor, Godsmark-Ford (McAteer 64); Hulme, Wright (c), Tavares (Arlott-John 45), Flynn, Suengchitthawon (Fitzhugh 85); Wakeling, Reghba (T. Pennant 64).
Subs not used: Doherty, Fitzhugh, Russ, Yfeko.
Goals: Wakeling 35', Suengchitthawon 56'.
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