Dawson joined the Baggies back in 2010 from Rochdale on a three-year deal before returning to the League One side on a season-long loan.
His latest contract will see him stay at West Brom until 2015 with an option of a further 12 months.
Since joining West Brom, the 21-year-old has made his debut on the international stage, featuring against Azerbaijan for the England Under-21s, a game in which he scored twice.
Baggies manager Roy Hodgson has been impressed with the youngster and is delighted to have him extend his stay with the Midlands outfit.
"We are very happy that Craig has committed his long-term future to the club,” he told West Brom’s official website.
"Since he joined up with the team at the start of the season, he has been very impressive, both in training and games.
"We believe Craig has got a very bright future as a Premier League player and it's nice that future is going to be with West Brom."