Skating in the last pairing of the two-race competition, Lee held off the charging Wolf to continue a brilliant Olympics showing by the Koreans.
The bronze medal went to China's Wang Beixing.
Lee had a combined time of 76.09 seconds for a victory margin of just five-hundredths of a second over silver medal winner Wolf. Beixing had a cumulative time of 76.63.
"All my friends have won medals so I was a bit under pressure but the very hard practice paid off," Lee said.
Ranked third in World Cup standings, Lee carried a slender lead over world record holder Wolf into their dramatic duel at the end.
The Korean clocked 37.85 seconds, while Wolf registered 37.83 in their showdown race for the fastest time around the oval on the day but not good enough to overtake Lee.
Lee carried a flag around the track in celebration, while her coach pumped his fists in excitement in the infield. On the podium she waved her hand over her face as emotion began to overtake her and her eyes reddened.
Her sensational victory followed the unexpected gold medal triumph on compatriot Mo Tae-bum in the men's 500 metres on Monday and gave the Koreans a sweep of the sprint titles.
Lee Seung-hoon of South Korea got his nation off to a great start by claiming the silver medal in the men's 5000 metres that kicked off the competition on Saturday.
Wolf, who has won the World Cup every year since 2005 and has three consecutive world single distance titles under her belt as well, blamed a sleepy first run for her loss.
Her main pre-race rival Wang Beixing also had a slow first just before Wolf’s.
"Beixing’s first run maybe made me a bit sleepy. So in my first race I was far too slow, not aggressive enough."
The Berliner spectacularly upped the ante in the second run, shaving almost half a second off her time but in the final 50 metres the Korean caught her up.
"I thought I had it, going into that second curve, but that second curve was hard. I could feel it was my second race of the day."
Canadian skater Christine Nesbitt said the Korean charge could be expected given their success in short track, where they have collected 18 gold medals overall.
"They have always had a very strong sprint programme," Nesbitt said. "They are a strong nation in short track and as much as they are a different sport, you can translate it."
Sophie Muir, the former world inline skating champion who switched sports to become the first Australian speed skater at an Olympics, finished 29th in the field of 36.
The 26-year-old was less than thrilled with that result but said she believed she could contend for a medal at the next Olympics in Sochi - if she could find a way to find some financial backing to help her stay in the sport.
"I was literally living on the scraps of the cash I had left over from when I worked full time two years ago, so I was really scraping the bottom of my bank account," she said about her last year in the Netherlands, training on the ice.
"If we don't get any kind of help I don't know how I'm going to make it through the next four years. It's going to be tricky but I love it and I'm enjoying it."
Place of birth: Seoul, Korea
Residence: Kyungkido, Korea
Previous Olympic results:
Fifth place, 2006 Winter Olympics, 500m
19th place, 2006 Winter Olympics, 1000m
2x bronze medallist, 2009, 2005 World Single Distance Championships, 500m
Runner-up, 2006/07 World Cup, 500m Third place, 2009/10 World Cup, 500m
Third place, 2008/09 World Cup, 500m
Lee beat Germany's three-time world single distance champion and four-time World Cup overall winner Jenny Wolf by the narrowest of margins to claim Olympic gold in Vancouver.
The 20-year-old, third in this season's World Cup 500m rankings, enjoys playing computer games and listening to music.