The world number two, who left the London Games with a silver medal four years ago amid tears and a spat with the referee, fell on her knees and sobbed into her hands after she sealed the final point.
The two were matched set for set throughout, winning points by returning hard-of-reach shots, trickery and sharp smashes, but Li slid behind in the final set, losing 11-7.
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North Korea's Kim Song I, who was playing in her first Olympics, took bronze with a 4-1 win over Japan's Ai Fukuhara amid loud cheers by her country's delegation in the crowd.
Kim hugged her coach and cried into her towel after her win, and ran off when reporters tried to approach her for questions.
The China vs China final reflected the country's continued domination of the sport. World number one, Liu Shiwen, watched the match from the sidelines after failing to be picked for the singles event.
The country took all six Olympic medals in the men's and women's singles event in 2008, prompting a rule change to only allow two players from each country compete. This, however, did not stop them from sweeping the gold and silver spots in London.
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