The controversial laws, which were introduced in 2014 in the CBD after the deaths of one-punch victims Thomas Kelly and Daniel Christie, will be wound back in the new year everywhere except Kings Cross.
New South Wales Premier Gladys Berejiklian on Thursday announced the changes, which will also remove restrictions on serving cocktails, shots and drinks in glasses after midnight and remove the 10pm curfew on bottle shop opening hours.
A 3.30am last drinks curfew will also be implemented - a 30-minute extension that went against the 3.00am curfew recommended by doctors.
St Vincent's Hospital has expressed "dismay" at the government's decision to extend last drinks and bottle shop opening hours, against its recommendations.
"After five years of these laws keeping people safe from alcohol-related harms, this is a very disappointing conclusion," St Vincent's director of emergency Dr Paul Preisz said in a statement on Thursday.
"All the evidence tells us, here and overseas, that for every extra hour alcohol is sold, there is a corresponding increase in harm."
The government has pledged a review of the changes in 12 months.
"We did not take this decision lightly," Ms Berejiklian told reporters in Sydney.
"Community safety is the number one priority but governments always have to balance community safety along with other considerations."
The lockout law changes come after a parliamentary report by the Joint Select Committee on Sydney's Night-time Economy in September recommended the removal of the laws in the CBD, saying they cost NSW $16 billion a year.
The premier said while the lockout laws had made Sydney safer, it was now time to encourage the city's 24-hour economy.
NSW Labor leader Jodi McKay on Thursday told reporters she welcomed the changes but said they should be made in the next week so businesses hurt by the laws could benefit from the festive season.
"We are disappointed that it hasn't been implemented sooner," Ms McKay said.
"Our one major concern is in regard to the lack of oversight by a minister for the night-time economy.
"This is more than just a regulation issue, it's more than just changing the time, this is an issue about how we revitalise our CBD."
Earlier, the premier dismissed the need for the role, saying ministerial responsibility would fall under the portfolio of Tourism Minister Stuart Ayres.
City of Sydney Lord Mayor Clover Moore on Thursday told reporters the city was "rejoicing" at the news.
"This is a really exciting day for our night-time economy, for our musos, for hospo workers, for business in the city," Ms Moore said.
The parliamentary committee report, released on September 30, said the Kings Cross precinct is "not yet sufficiently changed" to warrant the removal of lockout laws, and the issue should be revisited in 12 months.
It said the repeal of lockout laws in Kings Cross, without improvements to lighting, street layout and venue density, would prompt a return to excessive alcohol consumption and violence.
