The Organisation of African Unity, which is brokering indirect talks in Algiers, says the proposal contains details for a ceasefire and troop withdrawals as a first step to resolving the dispute.
Eritrea has said its forces defeated an Ethiopian attack after a day-long battle on Saturday near the Red Sea port of Assab.
"They have been completely repulsed," Eritrean presidential adviser Yemane Gebremeskel said.
"One of their divisions has been almost completely destroyed."
There was no independent confirmation of the fighting.
Eritrean President Isaias Afwerki denied that his country was losing the war and accused the international community of failing to put pressure on Ethiopia to stop its advance.
Observers
Anthony Lake, the US envoy at the Algiers talks, said that progress was being made, but it was too early to predict the outcome.
"The atmosphere is good," he said.
The latest peace plan includes provision for the eventual deployment of international observers along the disputed border, according to a Western diplomat.
Ethiopian Prime Minister Meles Zenawi said on Saturday that his country's forces would withdraw from Eritrean territory they now occupy, if an international force were stationed on that land.
The two countries share a poorly defined border some 1,000km (620 miles) long.
Prisoners of war
Ethiopia is holding 1,500 Eritrean prisoners of war at a makeshift camp in the north of the country.
A BBC correspondent who visited the camp said that the captured Eritreans are disillusioned with the war and hope it will end.
They receive basic food and water rations, but medical supplies are limited.
Sudan has urged the international community not to forget the thousands of Eritrean refugees who have fled into the country to escape the fighting.
An estimated 50,000 refugees fled from western Eritrea into Sudan last month.
As many as 750,000 Eritreans are thought to have been forced to flee their homes and farms as Ethiopia's army advances.
World Food Programme spokeswoman Lindsey Davies said most of the displaced had moved to camps and were in "fair" condition.
They had left their farms during the crucial planting season, she added, and would need to be back in the fields within two months if they were to harvest crops in November.
"Obviously the big concern is how long are these people going to have to stay in the camps," she said.
She said the WFP plans to fly in 325 tonnes of emergency food supplies by next Friday.