Obama, 48, wins the award while still being the commander-in-chief of US-led wars in Afghanistan and Iraq.
"Only very rarely has a person to the same extent as Obama captured the world's attention and given its people hope for a better future," Thorbjoern Jagland, the head of the Nobel committee, said.
"His diplomacy is founded in the concept that those who are to lead the world must do so on the basis of values and attitudes that are shared by the majority of the world's population.
"Obama has as president created a new climate in international politics.
"Multilateral diplomacy has regained a central position, with emphasis on the role that the United Nations and other international institutions can play."
The prize is worth $1.4m, which will be handed over on December 10.
The only US presidents to have won the award while in office were Theodore Roosevelt in 1906 and Woodrow Wilson in 1919.
Kristian Berg Harpviken, from the International Peace Research Institute, told Al Jazeera: "I was very surprised ... On the other hand what I did expect this year was a daring prize.
"I mean by daring is a prize that went to somebody who is not only rewarded for past achievements but who actually stands in the midst of a historical engagement.
"In other words, I was expecting the committee to want to use the political weight of the prize to make a difference in the world. To award it to somebody who could take that political capital and run with it."
Harpviken said that Obama is yet to achieve any of his major objectives on the global stage but added "what Obama has done is to give a breath of fresh air to international diplomacy and to multilateral collaboration."
"He has done that but he has yet to prove that he can deliver. And on many of the concrete issues where he has made tall commitments and has high ambitions it is clear that the wind is not blowing his way and that it is going to be very difficult."
Governments and world players began reacting to the announcement of the award on Friday.
"[Obama] has not taken a single step towards peace in Afghanistan"
The Taliban condemned the decision saying that Obama has "not taken a single step towards peace in Afghanistan".
However, Hamid Karzai, the Afghan president, congratulated Obama, calling the announcement "appropriate".
An aide to Mahmoud Ahmadinejad, the Iranian president, said the award should prompt Obama to begin to end injustice in the world.
"We hope that this gives him the incentive to walk in the path of bringing justice to the world order," Ali Akbar Javanfekr, Ahmadinejad's media aide, said.
"We are not upset and we hope that by receiving this prize he will start taking practical steps to remove injustice in the world."
Mohamed ElBaradei, the International Atomic Agency nuclear watchdog chief, said that he was "absolutely delighted" that Obama had won.
"In less than a year in office, he has transformed the way we look at ourselves and the world we live in and rekindled hope for a world at peace with itself," he said in a statement.
"I cannot think of anyone today more deserving of this honour."