The country also warned that the decision could compromise its relations with Norway.
Chairman of the Norwegian Nobel Committee, Thorbjørn Jagland, announced in Oslo on Friday that Liu Xiaobo had won the Nobel Peace Prize for his "long and non-violent struggle for fundamental human rights in China."
Liu has been active in his fight for human rights for the past two decades. He protested in Tiananmen Square during the 1989 massacre there. He also co-wrote "Charter 08", a manifesto demanding expanded freedoms in China. It was published on the 60th anniversary of the United Nations Declaration of Human Rights.
The police arrested Liu shortly before the Charter was released. He is now serving an 11 year prison sentence for speaking out against the Chinese government.
The announcement has already prompted other nations, from Germany to Taiwan, to demand Liu's release, so that he can attend the ceremony in Oslo in December and collect his prize.
Swedish foreign minister Carl Bildt wrote on his blog that his hope is that China will see the prize to Liu as a call to go further towards a more open and harmonic society.
The Committee warned that as China has advanced to become the world's second largest economy, the nation must take responsibility. It is in breach of several international agreements of which it is a signatory. The Committee also accused China of breaching its own Constitution, which guarantees political freedoms, like freedom of speech, press, assembly, and demonstration, to its citizens.
The Committee underlined that although many Chinese are taking part in the struggle for human rights, they decided to award Liu the Prize, because he symbolizes them.
The Peace Prize is the only Nobel Prize that is not awarded in Stockholm, at the time of Alfred Nobel's death Sweden and Norway were in a political union, and he wanted one of the prizes to be awarded in the other half of the union.