Merkel said the troop increase was part of a "completely new" approach to cooperating with the Afghan government which aimed to see Kabul take responsibility for the security of the country as soon as possible.
"We have developed a complete package for our future engagement ... which takes it to a new level, namely a new phase in handing responsibility to the Afghan government," Merkel said in Berlin ahead of the arrival of Afghan President Hamid Karzai for talks. "There can be no security without reconstruction, but on the other hand there can be no reconstruction without security."
The chancellor said Berlin would also provide €50 million to a $500-million international fund to bring insurgents into the mainstream, and roughly double development aid to €430 million.
German troops currently form the third-largest contingent in the 110,000-strong international force behind the United States and Britain, with the upper limit capped by parliament at 4,500 soldiers.
Berlin currently has around 4,300 troops in the struggling country, the bulk of them in the north.
With the addition of 350 extra reservists, who could be deployed for a limited period of time, the upper limit for Germany would rise to around 5,350 troops.
Berlin stressed that it would begin this year to hand over responsibilities to the Afghan government this year, and that it wanted its soldiers to start coming home in 2011 - a target shared by US President Barack Obama.
"In the next four years we want to create the conditions to enable our military presence to be wound down gradually ... We want to begin this year, step by step," Foreign Minister Guido Westerwelle said.
Merkel noted, however, that the plans did not include setting a fixed date for the complete withdrawal of Germany's troops in the country.
Asked how Germany's new commitments would be received by the US administration, which is pressing its allies to back its "surge" of 30,000 more US soldiers, Merkel said she was comfortable with the new offer.
"It was not the case that the Americans asked us what we wanted to do but rather we determined ourselves what we intend to do," he said.
"I think that if Germany plans to train at least one-third of the police forces in Afghanistan, if it doubles what it is doing in terms of civil reconstruction and we make our entire approach more effective and harmonise it with the international community, plus adds 500 troops and a flexible reserve of 350 troops, then we have nothing to be ashamed of," she said.
Her comments came ahead of a two-day visit to Berlin by Afghan President Hamid Karzai, who is making the stop over ahead of his appearance at the London conference.
Karzai, under pressure from his Western backers to tackle rampant corruption, hopes for Western support at the conference for his strategy of wooing Taliban fighters with the lure of jobs and money.