After posting the highest Test score at the MCG early on the final day, the home side rolled Pakistan midway through the final session for 163.
Mitchell Starc Photo: Photosport
Playing his first Boxing Day Test, Mitchell Starc capped a dream match with 4-36 in the second innings, which came after his heroics with the bat earlier in the day.
The miracle win means Australia takes an unbeatable 2-0 series lead into the New Year Test in Sydney.
Pakistan had control of the game after opener Azhar Ali led the way with an unbeaten 205 and they amassed 9 (dec)-443 in their first innings.
But the tourists then lost their way with indifferent bowling and fielding, before Friday's disastrous second innings effort.
After four days of persistent rain delays, a tame draw still appeared the most likely result.
But resuming their first innings on the last morning at 6-465, Australia capitalised on Pakistan's lack of urgency and ramped up the pressure with brisk scoring.
Australia declared at 8-624, topping the previous highest MCG Test innings score of 604 set by the home side in 1937.
Captain Steve Smith finished unbeaten on 165, taking his average to more than 60, while Starc set an MCG record for the most sixes in his sparkling innings of 84.
Starc bashed seven sixes during his 91-ball innings, breaking the previous mark of sixes that compatriot Andrew Symonds set in 2005 against South Africa.
Sohail Khan dropped a sitter of a catch in the deep off Azhar's bowling when Starc was 51.
Wahab Riaz's persistent no-ball problem also proved critical when he bowled David Warner on day three for 81.
But the umpire's arm was outstretched and Warner went on to score 144.
Wahab's no-ball and Sohail's dropped chance effectively cost Pakistan 96 runs, which made all the difference in their second innings.
Australia quickly made it "game-on" either side of lunch when they dismissed Sami Aslam and Babar Azam cheaply.
Then off-spinner Nathan Lyon took three wickets in the middle session to leave Pakistan in disarray at 5-91.
Lyon dismissed Younus Khan (24) and fellow veteran Misbah-ul-Haq in the same over, with the captain going for a second-ball duck.
Pakistan's two most experienced batsmen were out to poor shots.
Then Peter Handscomb took a great catch at bat-pad off Lyon's bowling just before tea to dismiss Asad Shafiq for 16.
And Josh Hazlewood trapped Azhar lbw for 43 early in the final session.
Shane Warne and fellow Nine commentator Mark Taylor were mystified when Smith did not bowl Lyon for 11 overs after tea.
Lyon's bowling failed to impress in the Pakistan first innings and he is under pressure to retain his Test berth.
But he was outstanding in the middle session, snaring 3-21 from 10 overs, and he finished with 3-33.
Sarfraz Ahmed and Mohammad Amir defied Australia with a 54-run stand for the eighth wicket.
Jackson Bird broke their resistance when he bowled Amir and 11 and 10 runs later Mitchell Starc bowled Sarfraz for 43.
- AAP
