Defending champion Djokovic fought the Briton to a standstill in a 6-3 3-6 6-7 6-1 7-5 victory after almost five hours of heart-stopping, hand-wringing tennis at Rod Laver Arena.
After finally swatting away Murray's semi-final challenge, the world number one crumpled to the court in exhausted relief, barely able to flick off the moths fluttering around his arms.
Murray could easily have walked away as the winner, Djokovic acknowledged.
"Both of us believed that we can win, and that's how we played," he told reporters. "It could have easily gone the other way. He was a couple of points away from winning the match, so I was lucky to go as a winner."
A shattered Murray exited with his head held high after proving without doubt he belongs in the elite company of Djokovic, Nadal and Roger Federer - beaten by the Spaniard in Thursday's first semi-final.
"Tonight's match was important for many reasons," said a drained Murray. "Obviously I wanted to win first and foremost. But after the year that Novak's had, I think there's a very fine line between being No. 1 in the world and being three or four.
"I think that gap, I feel tonight I closed it."
The runner-up at Melbourne Park for the last two years, Murray had been in top form coming into the last four.
The addition of eight-times grand slam champion Ivan Lendl as coach has brought a more focused approach to his preparations and with confidence coursing through his veins, the Scot has added a more aggressive edge to his game.
Surprisingly it was the defensive-minded Murray of old that stumbled through the first set, as Djokovic dictated the pace of play, earning easy points off the 24-year-old's sloppy forehand and pouncing on a tame second serve.
Shoulders drooping and feet dragging, a muttering Murray looked a lost cause at 2-0 down in the second set.
But then the tide turned.
With Lendl concocting energy drinks in the players box to fuel the Murray machine, the Briton sprang to life, stepping in on the Djokovic serve and finding his range from the baseline.
Even the stoic Lendl was caught up in the moment, pumping his fist at a marvelous Murray winner before settling back in his chair in stony-faced silence.
With the match tied at 1-1, Murray came through a thrilling third set tiebreak to move within a set of victory.
However, the momentum swung once again in the world number one's favour as Murray came out flat for the fourth set.
The final set was another fought tooth and nail as Murray battled back from three games down but Djokovic had enough gas in the tank to secure the win.
The defeat left Murray still searching for his maiden grand slam title but Djokovic thought the Scot was not far away.
"He's so close to winning a grand slam. He's one of the best players in the world, that's for sure," he added.
Victoria Azarenka has cemented her place among the top players in the world by reaching the Melbourne Park final, but the women's world number three is getting fed up with the hubbub surrounding her serial grunting.
The 22-year-old Belarusian will play in her first grand slam final on Saturday against Maria Sharapova, also one of the loudest players on court.
While Azarenka, who would become world number one with a victory on Saturday, has worked hard to block out distractions on court she knows there is no way of silencing the shrieks of Sharapova.
"Well I'm not deaf. Of course I hear her," Azarenka told reporters on Friday. "I'm sure she hears me. And about 15,000 people hear us maybe even further away."
Svetlana Kuznetsova and Vera Zvonareva also made some noise by beating Italians Roberta Vinci and Sara Errani 5-7 6-4 6-3 to win the women's doubles title.
The unseeded Russians captured the decisive break in the second game of the third set and survived five break points before closing out the match on the third match point.
