"After the obstruction of progress and due to the threat to the supreme national interests it was decided to go back to the nation," said a decree issued by Emir Sheikh Sabah al-Ahmad Al-Sabah.
Following the move, new general elections must be held within 60 days under Kuwaiti law, and another decree was expected to be issued soon to set the date for those polls.
The decision came a week after the emir accepted the resignation of former prime minister Sheikh Nasser Mohammad al-Ahmad Al-Sabah, a senior member of the ruling family, following demonstrations led by youths and opposition MPs.
Tens of thousands of Kuwaitis staged the biggest rally ever in the capital Kuwait City on November 23 calling for parliament to be dissolved and snap polls held in prelude for major democratic reforms.
The liberal Progressive Movement welcomed the decision, saying it would reduce tension in the emirate, but demanded fundamental reforms to resolve the political turmoil that has dogged Kuwait for years.
There should be "political and constitutional reforms leading toward a fully-fledged parliamentary system and (the ruling family) should not continue its monopoly on sovereign ministries," said the movement in a statement.
It also called for political parties to be legalised and other reforms, insisting the crisis in Kuwait would continue unless the reforms were not carried out.
Last week, the emir appointed former defence minister Sheikh Jaber Mubarak Al-Sabah as the new premier. He chaired the outgoing cabinet on Tuesday and recommended the emir dissolve parliament.
The resignation of Sheikh Nasser, 71, came after youth activists and opposition MPs mounted a campaign to oust him, citing allegations of corruption and mismanagement.
The campaign intensified in August following a corruption scandal in which about 15 of the 50-member parliament allegedly accepted large deposits into their bank accounts, estimated by the opposition at $350 million.
In September, the public prosecutor opened an unprecedented probe into the accounts of the suspected MPs after receiving information from banks that large sums of money were deposited from unknown sources.
Hundreds of youths and opposition MPs stormed the parliament building following a violent rally on November 16 that later led to the arrest of around 33 activists. They were released last week.
"Youth activists sparked the nationwide protests and this is the fruit of their efforts," top youth leader Mohammad al-Bulaihees told AFP after parliament was dissolved.
"The young activists will play an important role in the election to back opposition candidates" who support more freedoms and equality, he said.
Bulaihees said youths would press on for deeper reforms including a constitutional monarchy, an elected government, legalising political parties and electoral law changes.
Kuwait has been rocked by political crises since Sheikh Nasser, a nephew of the emir, was appointed premier in February 2006, stalling development despite abundant wealth.
During that period, he resigned seven times and parliament was dissolved on three occasions in 2006, 2008 and 2009.
Although parliament has vast legislative powers and monitors the government, it cannot vote a cabinet out of office. But it can stage no-confidence votes targeting individual ministers.
Since embracing parliamentary democracy in 1962, the Kuwaiti assembly has been dissolved seven times, including two suspensions in 1976 and 1986.
Kuwait is OPEC's third largest producer, pumping around 3.0 million barrels of crude oil per day. It has a native population of 1.2 million people, besides 2.4 million foreign residents.
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