The 29-year-old has been a huge success since joining City from Barcelona for around £24m in the summer of 2010 and will now be staying until at least 2017.
Toure capped his first season in England by scoring the winning goal in the 2011 FA Cup final against Stoke and his dynamic midfield displays were a huge factor in City's Premier League title-winning 2011/12 campaign.
And the Ivory Coast international has been named the African Player of the Year for both 2011 and 2012.
"This is where I want to be," said Toure, after signing his new deal. "When I first arrived at City, every time I went to sleep, I would dream about us winning something.
"Now, it is about us being the best team in whatever competition we take part in.
"I will never forget how I have been treated here by the fans, the club, and the owners, and nothing would give me greater pleasure than to finish my career as a Manchester City player.
"I want to continue winning titles and trophies and continue to make history. I have enjoyed all of my time here and can't wait for the next chapter.
An incredible club
"This is an incredible club to be a part of, with fans who support a team to the end, whatever the circumstances."
City are not on course to retain their title, as they are 15 points behind neighbours Manchester United, but they are second in the standings and have an FA Cup semi-final against Chelsea on 14 April to look forward to.
Toure added: "Of course now it looks likely that we will not successfully defend the Premier League title and that is sad for all of us.
"But we can still finish second and win the FA Cup for a second time in three years, and that is still an achievement for a club that won nothing for a long time.
"We must try to finish on a high note and then start preparing to win more next season. Football is always a challenge and always a problem to solve and that is why we all love the game.
"You have to use your skill, intelligence and strength to constantly improve, and that is what we at City intend to do."