The Bombers had come into the match undefeated and were fancied by many to inflict Collingwood's first defeat on Anzac Day since 2009.
But despite a peerless performance from Dane Swan, who silenced the critics with an Anzac Day medal-winning performance, Collingwood was overtaken by a late Essendon charge before a frantic final two minutes clinched victory.
It took a video replay, however, to confirm the winning goal.
Essendon's Brent Stanton - who had gone missing for much of the day thanks to a marvellous defensive performance from Martin Clarke - had snapped a goal out of nowhere to silence the Collingwood supporters with two minutes left.
But as Collingwood surged forward, the ball came inside the forward 50 and bounced into the goal square, where Blair aimed a wayward kick at the Sherrin.
The ball dribbled over the goal line to cause pandemonium, but it took a minute's review to confirm that the ball had glanced off the Collingwood player's leg, making the goal legal.
Essendon tried to snatch a late draw or win, but fittingly, it was Swan who took his sixth mark in defence to seal the win.
Challenged by critics about his fitness and performance in recent weeks, Swan responded on the big stage with a dominant performance that included a massive 42 possessions, six tackles and three priceless goals.
Despite the wet conditions, tall forward Travis Cloke also kicked three for Collingwood, but it was the smaller players who did the damage for Essendon, with three to Alwyn Davey and two to David Zaharakis - who was the hero of Essendon's last Anzac Day win in 2009.
The one-point margin was the closest finish between the two arch-rivals on Anzac Day since the 1995 draw.
The match represented something of a changing of the guard, marking the first time that neither Kevin Sheedy nor Mick Malthouse was present in the coaches' boxes for this storied fixture.
Their places in the coaching hot seats are now occupied by James Hird and Nathan Buckley, who had previously saved many of their greatest on-field exploits for the biggest day on the AFL home-and-away calendar.
Collingwood improved their win-loss record to three-two, while Essendon dropped their first game of 2012.
Collingwood have now won six of the past seven Anzac Day encounters - but this was the toughest of the lot.
Collingwood 2.4 5.6 9.8 11.14 (80)
Essendon 1.3 3.6 7.8 11.13 (79)
Collingwood: D Swan 3 T Cloke 3 J Blair 2 D Beams D Jolly S Sidebottom.
Essendon: A Davey 3 D Zaharakis 2 A Monfries B Howlett B Stanton C Dell'Olio H Hocking S Lonergan.