"The European Parliament acknowledges the incredible strength of this young woman," said Martin Schulz, the president of the EU legislature.
"Malala bravely stands for the right of all children to be granted a fair education. This right for girls is far too commonly neglected."
The 16-year-old activist was shot by the Taliban last year in Swat Valley of Pakistan for speaking out in favour of girls' rights to education and is also in the running for the Nobel Peace Prize.
"Today, we decided to let the world know that our hope for a better future stands in young people like Malala Yousafzai," said the chairman of the conservative European People's Party (EPP), Joseph Daul.
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US whistleblower Edward Snowden had also been a contender for the prize. The 50,000 euro (USD 65,000) prize is considered Europe's top human rights award.
Malala rose to prominence in 2009 when she wrote a blog for the BBC Urdu service about her life under Taliban rule and the lack of education for girls.
Past winners of the EU's prestigious prize include South African anti-apartheid hero Nelson Mandela, former UN secretary general Kofi Annan and Nobel Peace Prize laureate Aung San Suu Kyi.