Price, widely considered Britain's best heavyweight prospect since Lennox Lewis, was caught by a fairly innocuous-looking shot to the temple and went down.
The punch from the American caught the hometown boxer around the back of his left ear, perforating his eardrum.
Price got to his feet but was clearly struggling to keep his balance and the referee had no option but to declare Thompson the winner.
According to the Telegraph, Price's promoter Maloney sunk to his knees after the card at the Echo Arena and had to be taken to hospital.
Price had got off to a solid start, using his height and reach advantage to control the opening round.
But Thompson went all out from the start of the second round and soon had Price on the ropes before sending him to the canvas.
"I've been doing that to other people since I turned professional," a philosophical Price said after tasting defeat for the first time as a pro. "It's heavyweight boxing, nobody's invincible. I'll come back from it.
"I didn't take a beating in there tonight - it was one of those shots. It caught my ear and my balance had gone. Sometimes it's best to come back as quickly as possible.
"I'm still the British and Commonwealth champion and, three fights down the line, this will be ancient history."
Thompson said: "I knew I would do this, it's no shock to me. They thought I was just a name for his record but I showed everyone that I've got a lot left."