At a special event in San Francisco, Apple boss Tim Cook revealed the new phone and demonstrated the features it will include.
Rumours circulated on social media sites for months about what form the phone would take. The most noticeable difference is the bigger screen size.
The iPhone 4 came with a 3.5 inch display but this has increased to 4 inches on the iPhone 5. The new screen also has a new 16:9 ratio which will allow for better viewing of widescreen video.
Apple claim the phone will be thinner and lighter as it now comes with a new aluminium design. "The iPhone 5 is the most beautiful consumer device that we've ever created," said Philip Schiller, Apple's senior vice president of worldwide marketing.
The iPhone 5 will have a longer battery life, according to Apple
"We've packed an amazing amount of innovation and advanced technology into a thin and light, jewel-like device with a stunning 4-inch Retina display, blazing fast A6 chip, ultrafast wireless, even longer battery life; and we think customers are going to love it," he said.
One reason for the increase in display size is that Apple's rivals have already been selling phones with bigger screens. With the iPhone 5, Apple hope to close that gap.
The phone also has a built-in 4G capability to allow super-fast mobile broadband connection to enhance file-sharing and video-streaming.
Although 4G has not been introduced to Britain yet, UK phone operators have plans to launch a new 4G network to 20 million people in 16 cities in time for Christmas.
Apple once dominated the smartphone market and hopes their new product will allow it to catch up with rivals Samsung.
The product is expected to go on sale in the US from September 21 and in other countries approximately one week later, though the phone will be available to order in two day's time.
The phone's display has increased in size from 3.5in to 4in
Apple executives are hoping there will not be a repeat of the technical problems that appeared after the launch of the iPhone 4 in 2010.
Purchasers discovered the unit rapidly lost signal strength if it was held with the user's skin bridging the gap between the left and bottom antennas built into the phone.
Former Apple boss Steve Jobs was later forced to issue guidance for users which suggested they hold the unit in a different way.
The iPhone 5 will also include Apple's new A6 chip, giving the phone a faster processing speed, as well has having a longer battery life. Apple is claiming users will be able to obtain 8 hours of 4G browsing with the new battery.
But there has been no significant upgrade to the rear camera, which will remain at 8 megapixels. But a new panorama mode will mean users can now take 28 megapixel pictures using the eight megapixel camera.
Demonstrating the new feature, Apple executive Phil Schiller joked: "The world is just a more beautiful place when you use an iPhone 5".
An eagerly awaited feature of the phone is the 4G capability
But not everyone welcomed the new design. Some Apple fans took to Twitter to express their disappointment. One user said: "I hate to be a killjoy. But what's so spectacular about the iPhone 5? I'm not seeing it."
Another said: "No iPhone 5 for me hate how it looks!"
One design change sure to infuriate many iPhone owners who want to upgrade to the new model is the loss of the traditional 30-pin dock connector which has been around since the first iPod.
In its place there will be a new "lightning" connector which will be much smaller and which can be inserted in the up or down position.
But adaptors will be available which mean old iPhone users will not have to throw away their old cables and connectors.
Another new feature is 'Passbook', which will allow users to store tickets for concerts and boarding passes.
Siri was one of the most talked-about features included with the iPhone 4S. It enabled users to control their phone using their voice.
But the ability of Siri to recognise voice commands and the list of functions it controlled was limited. Apple claims that users of the new iPhone will be able to use Siri to post messages to Facebook.
Despite Apple's slick launch and marketing of the phone, rival's Samsung still lead the smartphone market with a 32.6 percent share. Apple still only has 17 percent, according to market research firm IDC.
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