The young Serb, who is seeded sixth, showed the type of form that saw him storm to the Sony Ericsson Open Masters title in Miami recently in a sublime first set of tennis.
However, he then just seemed to lose his focus in the second set as he was broken four times and hit 23 unforced errors to just six winners, which allowed former French Open winner Gaudio back into the match.
However, the Argentine was not quite able to take advantage of the Serbian's erratic performance, and when Djokovic managed to sort his serve out in the final set he was able to race to what was a reasonably comfortable victory in the end.
Monte Carlo Masters
Nadal claims first serve the key
22/04/2007 AT 17:17
"I got off to a good start but in the first game of the third set, I was lucky to save a break point," the world number seven said after the win.
"Then everything was much easier for me."
Swede Robin Soderling sent Russian third seed Nikolay Davydenko crashing out of the tournament with a 6-4 6-7 6-3 victory.
World number four Davydenko, who reached the French Open quarter-finals last year, lost the first set and was allowed back into the contest in the second when his opponent wasted two match points.
But Soderling finally emerged triumphant on his fifth match point.
Fifth seed Tommy Robredo cruised through to the third round dispatching Frenchman Arnaud Clement 6-3 6-2.
Tomas Berdych, Juan Carlos Ferrero and David Ferrer also made light work of their second round opponents recording straight set wins over Benjamin Becker, Nicholas Massu and Julien Benneteau respectively.
David Nalbandian became the latest seed to fall when he retired injured during his match with Philipp Kohlschreiber.
The ninth seeded Argentinean was trailing 5-7 1-4 when he was forced to retire.
Richard Gasquet showed no signs of fatigue after his mammoth three and a half hour, first round match when he dispatched Dominik Hrbaty 6-3 6-2 to progress to the third round.
Gasquet raced out to a 5-0 lead in the first set before suffering a slight lapse in concentration allowing his Slovak opponent back into the match.
But the 20-year-old Frenchman broke early in the second set to reinstate his dominance before running away with the match.
Ivan Ljubicic, who will now face Gasquet, was the final player to book his place in the third round when he snuck past Czech Radek Stepanek 7-6 7-6 in a match lasting almost two and a half hours.
Monte Carlo Masters
Fed: Rafa forces me to improve
22/04/2007 AT 16:39
Monte Carlo Masters
Nadal wins third Monte Carlo title
22/04/2007 AT 12:17