In a statement, the Israeli army said the low-ranking officer underwent a hearing and was sentenced to 14 days in prison before being discharged from service. No one was wounded in the incident.
Palestinians have frequently complained that Israeli officers and soldiers are rarely punished for mistreatment of Palestinian civilians.
"A deputy company commander in an infantry battalion was relieved from his duties, following inappropriate behaviour towards Palestinian civilians," the statement said.
"Several weeks ago, during operational activity (near a Jewish settlement) the officer used a shock grenade at a group of youngsters gathered alongside the road."
In a separate case, the statement said a soldier was sentenced to 35 days in prison for kicking a Palestinian during an argument near the West Bank city of Qalqilya.
The exceptional statement came weeks after Israel's army chief criticised hardline security measures against the Palestinian population during the three-year-old intifada or uprising for statehood.