The city has traditionally been an important centre on the routes westward from Kunming (the provincial capital) to the Tibet Autonomous Region and northern Myanmar (Burma); Dali also has routes leading south into the wild southwestern region of Yunnan. It was established as a city in 1983 through the merger of Dali county (containing the town of historical Dali) with the city of Xiaguan. Xiaguan is now a district of Dali city, and historical Dali is administered as a town under the newer city.

Xiaguan was first known to the Chinese in the mid-8th century as Longweicheng; at that time it was built by Poluoge, king of the Nanzhao kingdom located in the area. After the occupation of the region by the Mongols in the late 13th century, it became a customs station and tax office, known variously as Longweiguan, Huweiguan, or Xiaguan. It grew into an important market town for local produce and was a centre of trade between Chinese merchants and the various minority peoples living in the surrounding mountain districts. Its trade in the 19th century was largely founded on tea produced in the vicinity. It was also a tea market second only to Pu’er in Yunnan, and tea processing became an important industry in the early years of the 20th century. Its prosperity increased still further with the construction of the Burma Road during the Sino-Japanese War (1937–45), and its commercial role subsequently grew until it had become the chief collection and distribution centre in western Yunnan.

The contemporary city has remained a collecting point for cotton, tea, grain, sugar, pears, walnuts, and ham, as well as for fish from Lake Er; these products are mainly for shipment to Kunming. After 1949 the city experienced some industrial development, including grain milling, oil extraction, and tea curing. It also had some light engineering industries, such as the production of farm tools. Since the beginning of the 1980s, Dali has enhanced its economic status and become an economic and communication centre of western Yunnan. Newer industries include power generating, papermaking, cement manufacturing, marble processing and polishing, cigarette making, and food processing. The Yunnan-Tibet highway and the Kunming-Wanding highway (on the Sino-Myanmar border) cross there. In addition, a branch rail line from Dali to Kunming has been completed. A regional airport, which began service in the mid-1990s, now has regular flights to several Chinese cities.