Paraguayan President Horacio Cartes and Israeli Prime Minister Benjamin Netanyahu attended the inauguration ceremony on Monday.
Palestinian leaders see East Jerusalem as the capital of their future state and have said that US President Donald Trump's move disqualifies Washington's as a peace mediator.
Previous US presidents, as well as nearly every other country, refrained from opening embassies in Jerusalem, arguing that the city's final status should first be resolved through Israeli-Palestinian negotiations.
Later on Monday, Saeb Erekat, secretary general of the executive committee of the Palestine Liberation Organization (PLO), condemned the opening of the Paraguayan embassy in Jerusalem.
"We have witnessed today how the Paraguayan president is an irresponsible political leader by defying international law and the achievement of a just and lasting peace in the Middle East," he said in a statement.
Erekat also called the Arab world to boycott countries that relocate their embassies to Jerusalem.