"I consider the reaction of Russia as disproportionate," she said after meeting Medvedev in the Black Sea resort of Sochi close to the Georgian border and the Moscow-backed rebel region of Abkhazia.
At the tense news conference at the Russian leader's coastal residence, Merkel took a contrary stance to Moscow's view that the future of the rebel provinces would not be with Georgia.
"The starting point must naturally be Georgia's territorial integrity," Merkel said. "There is an elected government in Georgia with which we have to discuss and negotiate."
However, Medvedev said he saw little chance of either rebel region rejoining Georgia after the latest violence and added that Russia would act in the same way in future to protect its citizens.
"Unfortunately after what has happened it is unlikely Ossetians and Abkhaz can live in one state with Georgians," he said. "If someone continues to attack our citizens, our peacekeepers, then of course we will answer just as we did."
The meeting came as US Secretary of State Condoleezza Rice was in Georgia to show support for the pro-Western government of President Mikheil Saakashvili and discuss a peace plan.
While Germany has close ties to Russia, Merkel has criticized Russia's military onslaught in Georgia, sparked last week by a Georgian attack on separatist South Ossetia.
Merkel earlier this week promised to have stern words with Medvedev over the conflict with Georgia. Her spokesman said that she would "make it clear" to Medvedev that the problems in the Caucasus region cannot be solved by military means, following the fighting between Russian and Georgian forces over the last week.
However Germany's desire not to isolate Russia has also been evident in diplomatic efforts to resolve the conflict. On Thursday, German Foreign Minister Frank-Walter Steinmeier urged the European Union to "keep the lines open" to both sides.
"We must criticize what needs to be criticized and we have done this in the past, including with clear words when necessary towards Russia... with regard to Russian bombing of Georgia and the presence of Russian troops in Georgia proper," Steinmeier said. "But we should also pursue a policy which is sensible and realistic."
The Russian ambassador to Germany, Vladimir Kotenev, told the German daily newspaper Bild on Friday that Medvedev would present evidence to Merkel that Georgian forces had committed atrocities in South Ossetia.
“The Georgian troops have murdered women and children, set churches full of refugees on fire and flattened entire villages,” Kotenev told the paper. “We can show concrete proof of this.”
He also said that Medvedev wanted to warn Merkel against letting eastern European countries have too much influence over the EU's policies toward Russia.
“President Medvedev doesn't want to split the EU, but he will make clear to the chancellor that eastern European EU members should not drive the EU's Russia policy all alone. That would prevent a true partnership,” he told Bild.
Polish President Lech Kaczynski has personally come to Saakashvili's defence, visiting Tbilisi earlier this week. Along with three other leaders of ex-communist EU states, he slammed the peace plan brokered by French President Nicolas Sarkozy to end the conflict for failing to insist on Georgia's territorial integrity.
But Kotenev also rejected international criticism of Moscow's actions in the Caucasus region.
"Whoever wants to pillory Russia now is putting credence in a Georgian regime responsible for a genocide. That mocks the victims,” he said, adding that it was up to the West if a “new ice age” with Moscow developed.
The location of Friday's meeting between Merkel and Medvedev, at a presidential residence in Sochi, had important significance for Russians as the resort is to host the Winter Olympics in 2014.
On Thursday two US lawmakers, Allyson Schwartz and Bill Shuster, began campaigning for the International Olympic Committee to pull the Winter Games from Sochi as punishment for Russia's actions.