Dr Salim said the new union would have a real impact on the ordinary African.
The 38-year-old Organisation of African Unity (OAU) has been dissolved to make way for the African Union.
OAU Secretary General Dr Salim Ahmed Salim made the announcement at the OAU headquarters in Addis Ababa on Friday. He said the African Union would bring a real change to the continent.
The union, which will also be based in Addis Ababa, will aim to unify the 53 African member states politically, socially and economically and will be loosely modelled on the European Union.
Dr Salim said the new union would have a real impact on the ordinary African.
The union will be multi-faceted, with an assembly made up of all the heads of state and an executive council compromising of all the ministers.
Although the details still need to be worked out, Dr Salim said that there would be a transitional period of approximately a year to allow the union to become fully operational.
Critics
There has been widespread criticism from all over the continent, with many labelling the union as a "waste of money" and "another autocratic nightmare".
Sceptics have also accused the African states of bowing to Libyan leader Colonel Gaddafi who first proposed the idea.
Many have even gone as far as to say it is an attempt by Colonel Gaddafi to take over the continent. Dr Salim however dismissed this.
Political analysts in Addis Ababa welcomed the announcement but remained sceptical, questioning whether Africa really is ready to take up the challenge.