The 37-year-old joined the Citizens on an initial two-year loan deal in 2019, with the club turning his temporary stay into a permanent switch.
Across his four seasons at the Etihad, the four-cap England international has made just two appearances in all competitions.
His debut under Pep Guardiola came in the 4-3 win away at Newcastle in May 2021, before playing against Sporting Lisbon in the Champions League last term.
Behind Ederson and Stefan Ortega in the pecking order, Carson has been named on the bench for just five Premier League matches this season.
But his experience has seen him rewarded with a deal until 2024, with the player failing to hide his delight at extending his stay.
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He told the club's website: "I'm excited to be staying at City for the 2023/24 season.
"I love working with Pep, Xabi Mancisidor and our incredible players every day. Hopefully I can help all of our goalkeepers be at their best."
Understanding his role in the team is to provide advice to Ederson and Ortega, Carson added: "I'm the third choice goalkeeper. I think it's half of my job role to help the lads if they need anything.
"The other two lads are playing a lot more games than me and could be called upon at any time so if they want me to do a bit of shooting or crossing I am there to help them.
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"If that means I'm there longer, it's not a massive thing to do. That's part of my role to be there to do that."
Carson's teammate Grealish hailed the announcement on social media, as he tweeted love heart and goat emojis, with the caption: "Best news ever."
And City fans were also loving it, as one user said: "This man's job behind the scenes must be doing a wonderful job. We salute him."
Another quipped: "Biggest transfer of the summer and we haven't even reached June yet."
A third added: "This just made my week, go on Scott!"
Meanwhile this supporter simply stated: "The goat of the team!"