The 26-year-old said: "I think there's a potential here that needs to be realised and, with the new owners as well, it's a really exciting time at Edinburgh.
"It's a fantastic city and the club is getting better and better.
"The signings we've made shows the direction we want to go in and I definitely want to be a big part of that."
Head coach Lynn Howells said: "Simon is a player who fetches more to the game than just playing. He is a good squad member who lifts morale.
"On the playing front, he has the ability to beat defenders and fetches another dynamic to our game, and he now brings stability to our squad as he'll be with us until 2009."
Executive chairman Alex Carruthers added: "Given we're in the entertainment business, it is important we have players of Simon's calibre and we are delighted to have him on board for another couple of seasons.
"He makes you sit on the edge of your seat every time he has the ball. He is a dynamic individual and a great guy to have around the squad as his enthusiasm is infectious."
Webster represented Scotland A in the Churchill Cup at the end of a season disrupted by injury.
He arrived at the Scottish capital side five years ago after turning professional with Northampton.
Webster joins Scotland team-mates Mike Blair and Hugo Southwell in extending their Edinburgh contracts.
The club have also added Stephen Larkham, Roland Reid, Augusto Allori and Scott Newlands to their squad in recent months.