The highly-rated 20-year-old has yet to make his top-flight debut but made a name for himself with an explosive run of 20 goals in 23 games while on loan to Dutch club Feyenoord last season.
Guidetti, who joined City as a 16-year-old, told the club's website, ww.mcfc.co.uk, that he is very pleased to stay on:
"I feel really happy of course, it's a fantastic football club and to sign a new deal is really, really good.
"I've been here for a long time and Manchester City are the ones who have helped me grow and develop into the player I am today, so I am very grateful for that and I've seen how the club has turned into one of the biggest clubs in the world and it is great to be a part of that."
Guidetti returned to City after suffering illness towards the end of the last campaign and he is still fighting his way back to full fitness.
"It's going well - I can run, I can shoot, I can pass, so I am definitely getting there, but we have to be a bit more patient and of course I want to get out there every day, it's what I long for."