In a match which more resembled a tournament final or semifinal due to the high caliber of the players, Murray led 6-3, 7-6 (2), 3-0 when Nadal went to the net to shake Murray's hand.
Murray will face Marin Cilic in the semifinals. The Croatian player beat No. 7 Andy Roddick 7-6 (4), 6-3, 3-6, 2-6, 6-3 earlier Tuesday.
"I lost to him the U.S. Open in straight sets, so I'm looking for a little revenge," Murray said of the 21-year-old Cilic.
Roddick struggled through a right shoulder injury in the match that impaired his movement, but he expects no long-term damage.
Nadal, who struggled with knee tendinitis and was unable to defend his Wimbledon title last season after beating Roger Federer in the Australian Open final, received on-court treatment from a trainer for a right knee ailment after losing the second set.
Three games later, the Spaniard decided he couldn't continue.
That leaves Murray, whose only trip to a Grand Slam final ended in a loss to Roger Federer at the 2008 U.S. Open, in the hunt to become the first British man to win a major in more than 70 years.
Still in the equation at Melbourne Park is three-time champion Roger Federer, who plays Nikolay Davydenko in the quarterfinals on Wednesday. Novak Djokovic, the 2008 champion, takes on the same year's runner-up Jo-Wilfried Tsonga in the other quarterfinal.
"I had to go for my shots, play big tennis. And when the big points come you don't want to play long points against Rafa," Murray said.
Roddick's only major has been the 2003 U.S. Open, the last time an American man won a Grand Slam singles title, marking the country's longest drought in men's majors.
Despite playing strongly in the third and fourth sets to level the match, Roddick fell apart in the final set, allowing No. 14 Cilic to break twice and send the last American man out of the singles draw at Melbourne Park.
Roddick said he didn't practice on Monday after feeling a twinge in his shoulder during Sunday's fourth-round win over Fernando Gonzalez.
"The trainer said it was stemming from the neck down," Roddick said. "By the end of the first set, I was pretty numb in the bottom two fingers. I could still hit it pretty hard; I was just having trouble controlling it."
Roddick took advantage of some mediocre serving by Cilic in the third and fourth sets. When the Croat's serve improved in the fifth, it was all but over.
"I was playing pretty high-risk and the ball was dropping in for a couple of sets," Roddick said.
Roddick had not come back from two sets down in a major since his semifinal win over David Nalbandian at the 2003 U.S. Open.
Seven-time Grand Slam singles winner Justine Henin hasn't won a major in two years because she hasn't played in one. Henin, who returned from 20 months in retirement, advanced to the semifinals by beating Nadia Petrova 7-6 (3), 7-5 to take out the last seeded player in her half of the draw.
Henin, unranked and playing on a wild-card entry at Melbourne Park, will face Wimbledon semifinalist Zheng Jie, who beat Russia's Maria Kirilenko 6-1, 6-3 to equal her Chinese record for the best run at a major.
"I just went for it with my heart. Finally I could make it, and I'm very happy," Henin said. "At the end I played much more aggressive tennis."
Henin ended a highly successful run in Melbourne for Petrova, who ousted two reigning major champions on her way to the quarters: U.S. Open champion Kim Clijsters in the third round; and French Open champion Svetlana Kuznetsova in the fourth.
Kirilenko had taken out big names in her section, too, starting with her 3-hour, 21-minute first-round win over 2008 champion Maria Sharapova and her fourth-round victory against last year's finalist Dinara Safina, who retired with a back problem.
The 23-year-old Russian was making her debut in the quarterfinals of a major and struggled with what appeared to be a hip or thigh problem. She was no match for Zheng, who reached the last four at Wimbledon in 2008 to become the first Chinese Grand Slam semifinalist.
"It's very amazing for me," Zheng said of being the first Chinese player to reach the Australian Open semifinals. She said her victories here in doubles helped. "I feel this court for me is lucky."
Henin retired in May 2008 while holding the No. 1 ranking and had not played at a major since losing in the quarterfinals to Sharapova at the 2008 Australian Open. Henin won the title here in 2004 and reached the final in 2006, when she retired due to stomach problems against Amelie Mauresmo of France.
The loss to Sharapova confirmed to Henin that she needed a break.
"There was my little voice that was saying to me that I should go away because I needed something else at that time, to breathe differently again without tennis," she said. Since her comeback, her inner feelings have changed, she added: "Little voice that is very positive. Thank you."
Despite the injury and associated pain, Roddick, who took two months off at the end of last year due to a knee injury, was also positive after his loss.
He was told by the ATP trainer that he wouldn't risk any serious damage by continuing playing Tuesday.
"All signs at this point are good," Roddick said. "Whether it was a nerve that was compressed or something, I don't know, cutting off something. But they don't think it's going to be anything too serious long-term. I'm sure we'll take the proper precautions and check it out."