The 38-year-old will become the first gay taoiseach and will also be the country's youngest ever leader.
Mr Varadkar beat his rival, Housing Minister Simon Coveney, with 60% of the votes to lead Fine Gael - the biggest party in the coalition government.
He will succeed Enda Kenny as leader of the centre-right party within weeks.
The former GP is the son of an Irish nurse and a doctor from India and much of the media coverage of his victory has focused on Mr Varadkar's background, age and sexuality.
The former first minister of Northern Ireland, DUP leader Arlene Foster, has spoken on the phone to congratulate Mr Varadkar. He has also received a letter from Prime Minister Theresa May.
Following the announcement on Friday evening, the new Fine Gael leader said he was "honoured" to accept the "enormous challenge" ahead of him with humility.
"If my election shows anything it's that prejudice has no hold in this Republic," he said.
"When my father travelled 5,000 miles to build a new home in Ireland, I doubt he ever dreamed his son would grow up to be its leader."
Mr Varadkar, who came out as gay in the run up to the 2015 same-sex marriage referendum, has been in charge of the welfare system.
He has come to personify the liberalisation of a country which was once regarded as one of Europe's most socially conservative nations - homosexuality was illegal until 1993.
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