The body of the 46-year-old woman was discovered on Sunday morning on Pha Ngan island after she headed to a beach late Saturday for the party, said Lieutenant Colonel Somsak Nhurod of the local police station.
Police named the victim as Astrid Al-Assaad Schachner, but the German embassy in Bangkok was unable to confirm the identity of the woman or release any details of the case.
"The police have arrested a 29-year-old man, who confessed to murdering the 46-year-old German woman," Somsak told AFP.
Somsak said the suspect - Tiwat Kasempoch - worked at a tattoo parlour where the victim was last seen on Saturday night.
"Tiwat said he was drunk and angry at her," Somsak said. "He found her alone outside a 7-Eleven convenience store so he invited her to join him on a motorcycle ride. They went together to the beach... he then strangled her with his hands," he added.
Pha Ngan's heady parties are famous among backpackers and tourists for drinking, dancing and drugs, and attract thousands of revellers each month.
Despite its reputation as a holiday paradise, Thailand has seen a series of tourist murders in recent years, including the shooting deaths of two Russian women whose bodies were found slumped on deck chairs in Pattaya in 2007.