The incident, the second such attack in Jewish west Jerusalem in three weeks, occurred while Israeli President Shimon Peres hosted Palestinian President Mahmoud Abbas at his official residence less than a kilometre (half-mile) away.
Israeli officials said the driver was a Palestinian from a village in an area of the occupied West Bank that Israel considers part of Jerusalem. Its residents have freedom of movement throughout the city and Israel.
"The bulldozer driver left a construction site, and hit two cars," a police spokesman said. "A civilian who saw what was happening, shot him. The bulldozer continued on its way. A border police patrol ... continued to shoot and the terrorist was killed."
The bulldozer also hit a bus. Emergency services said at least 16 people were hurt, one seriously.
There was no immediate claim of responsibility but the attack was praised by Hamas Islamists in the Gaza Strip as "a natural reaction to the crimes of the (Israeli) occupation".
Obama was scheduled to arrive in Israel from Jordan later on Tuesday and stay at Jerusalem's King David Hotel, a couple of blocks from the scene of the attack.
The area is one of the most heavily guarded in a city hit by multiple suicide bombings during a Palestinian uprising that began in 2000.
A bulldozer attack in Jerusalem on July 2 killed three Israelis. Its Palestinian driver, a resident of Arab East Jerusalem, was shot dead by an off-duty soldier and police.
Peace Prospects
Tuesday's attack coincided with the first visit by a Palestinian president to Israel's official presidential residence.
"I am full of confidence the problems will be resolved," Peres said after a red-carpet greeting for Abbas, who is engaged in statehood negotiations with Israeli Prime Minister Ehud Olmert that have shown little sign of progress.
"I feel both sides believe there is no alternative to peace," Peres said.
Senior Palestinian negotiator Saeb Erekat said before the meeting that Abbas would seek Peres's help to halt "settlement expansion that is undermining peace talks" that began at a U.S.-hosted conference in Annapolis, Maryland last November.
In his remarks at the presidential residence known as Beit Hanasi, Abbas said: "Despite the passage of time, despite difficulties and obstacles, there is an end to this long conflict."
Peres said he hoped to reassure Abbas that Israel remained committed to the U.S.-brokered negotiations despite a political crisis revolving around corruption allegations against Olmert that could lead to an early election.
"Although ... things on our side are not the most stable, I want to make clear that the desire to achieve peace remains stable," Peres, a former prime minister and Nobel peace prize laureate, told Israel Radio ahead of the meeting.
A Palestinian flag and an Israeli flag provided a backdrop as both men posed for photographs. Such trappings are absent when Abbas and Olmert meet at the prime minister's official residence in Jerusalem.
The United States hopes for a Palestinian statehood deal before President George W. Bush leaves office in January.
Olmert has been talking up peace prospects as he clings to office in the face of a police investigation into suspicions he illegally received money from a U.S. businessman who raises funds for various Israeli organisations.
Olmert and the businessman, Morris Talansky, have denied any wrongdoing. Olmert has said he would resign if indicted.
