The settlement started in 1835 when Elder John and Nancy Oatman established a tavern and a store. In 1837, a lottery was held among the settlers to determine who would name the town. Alexander Gardiner won and named the town Dundee in honor of his Scottish hometown. In 1843 Scotsman Allan Pinkerton, later the renowned detective, set up business as a cooper. The town was incorporated in 1867, four years before East Dundee.

Over the years there have been efforts to merge West with East Dundee, the village just across the Fox River. A 1956 referendum was approved by East Dundee but rejected by West Dundee. West Dundee approved a 1962 referendum, but East Dundee rejected it. Each town's retention of individuality dates back to their early days, when West Dundee's Scottish and English heritage kept it apart from its German neighbors in East Dundee.

According to the United States Census Bureau, the village has a total area of 2.7 square miles (7.1 km²), of which, 2.7 square miles (6.9 km²) of it is land and 0.1 square miles (0.2 km²) of it (2.92%) is water.