She won 517 votes to Merz's 482 in a run-off.
Germany's conservative Christian Democratic Union (CDU) newly elected leader Annegret Kramp-Karrenbauer (L) is congratulated by German Chancellor Angela Merkel (R) during the CDU congress on December 7, 2018 at a fair hall in Hamburg, northern Germany.
Merkel suddenly announced she would step down as head of the CDU in October this year, after the party took a severe drubbing in two big state elections this year.
Kramp-Karrenbauer has been the CDU's general secretary, in charge of day-to-day political strategy, since February. Federal health minister Jens Spahn came in third.
Follow Sputnik's live feed to find out more. She was greeted by a several-minute standing ovation, with some delegates holding up 'Thank you, boss!' placards.More news: Hawaiian Monk Seal Gets Eel Stuck Up Its Nose
She won a tough re-election battle in her native Saarland state on the French border in 2017, briefly halting a series of poll debacles for the CDU as it was racked by infighting over the refugee influx. "I truly wish the best for my party". She was at the funeral of George HW Bush on Tuesday.
Ms Kramp-Karrenbauer has said she wants to improve on Ms Merkel's legacy and has suggested she would encourage debate within her party on issues such as immigration to encourage new proposals that could become government policy.
Merz, 63, who lost out to Merkel in a power struggle in 2002 and is returning to politics after a decade in business, is backed by CDU members exhausted of Merkel's consensual politics. "The future will test our values we must always approach work joyfully", she said.
She would be the most unsafe candidate to face the centre-left Social Democrats and the ecologist Greens, he added.
A former state premier in Saarland, where she led a three-way coalition, Kramp-Karrenbauer has a reputation for uniting support across the conservative Christian Democratic Union (CDU) and a talent for striking alliances with other parties.More news: Former Pirates Player Jose Castillo Killed In Crash In Venezuela
Kramp-Karrenbauer has differentiated herself from Merkel on social and foreign policy by voting in favour of quotas for women on corporate boards and taking a tougher line on Russian Federation.
"We need to get rid of what's slowing us down", Kramp-Karrenbauer said "And for many entrepreneurs in this country, that means too few trained professionals, too much bureaucracy and too high costs".
By contrast, Merz takes clear positions that appeal to rank-and-file party members hungry for a more clearly defined party after 13 years under Merkel as chancellor. He wants tax cuts, a bigger German contribution to holding together the European Union, and a more robust approach to challenging the far right.
Mr Merz will benefit from the fact that 296 of the delegates at the congress - nearly a third - will be from his home state, the western region of North Rhine-Westphalia.
A senior CDU official, speaking on condition of anonymity, said many delegates were undecided before the congress and could be swayed by how the candidates present themselves on Friday.More news: Here's how Wisconsin Republicans want to strip power from incoming Democrats