Mr Berlusconi, a conservative billionaire media mogul, submitted his resignation to
President Carlo Azeglio Ciampi on Tuesday.
It follows his narrow defeat to Mr Prodi's centre-left alliance last month in Italy's closest general election in living memory.
Mr Berlusconi has been asked to stay on as care-taker prime minister in the interim before a new government is formed.
President Ciampi’s term runs out on May 18 which means he must decide in the next few days whether he will select Italy’s next Prime Minister or leave it to his successor.
Prodi ready
Romano Prodi is the most likely candidate that the president will choose and as such Mr Prodi has been continuing negotiations with his coalition on the composition of his potential government.
The 66-year-old former European Commission president said he wanted to be ready with a line-up by Thursday or Friday in case President Ciampi decided quickly to appoint him and ask him to form a government.
Mr Prodi’s coalition is a fragile alliance ranging from communists to centrists. According to reports he has already selected most of his ministers and key government appointees except for the portfolios of interior and defence.
Berlusconi to fight on
Mr Berlusconi was left with no choice but to quit after the new parliament elected speakers from Prodi's coalition to the lower and upper houses.
His resignation ends his five turbulent years at the helm of Italian politics but the 69-year-old Berlusconi insisted his fight was far from over.
"I am not giving up," Mr Berlusconi said promising tough opposition to a Prodi government.
Leading Italian analyst Massimo Franco, a political commentator for the Corriere della Sera daily, said Mr Berlusconi remained strong, noting his Forza Italia party was still the country's largest.
"He still has an admirable ability to interpret the country," Mr Franco said in a telephone interview with AP.
"The era of Berlusconi seen as a wizard who would solve the country's problems with a magic wand is over," said Mr Franco. "But Berlusconi as the symbol of a social bloc, of interests and fears of the left that remain strong in this country, is not done."
"They will miss me"
A renowned political showman, Mr Berlusconi used sheer force of personality to raise Italy's profile on the world stage, arguably for better or worse.
He befriended US President George W Bush, British Prime Minister Tony Blair and Russian President Vladimir Putin.
However some of Mr Berlusconi’s off-the-cuff remarks occasionally embarrassed the country, such as when he compared a German lawmaker to a Nazi concentration camp guard.
He constantly promoted Italy's cultural, social and economic wealth, but also boasted of his own riches and famously admitted to having touch-up cosmetic surgery around his eyes as well as hair-replacement surgery.
"They will miss me," Mr Berlusconi was quoted as telling his ministers shortly before handing in his resignation to the president.
Conflict of interest
But the out-going premier leaves behind a stagnant economy and a ballooning budget deficit.
Critics have accused Mr Berlusconi of busying himself more with passing legislation that would protect his business interests than with delivering the economic miracle he had promised voters.
He attracted conflict-of-interest accusations and charges he used the government to shield himself from prosecution. Mr Berlusconi responded by launching vehement attacks at Italian magistrates, who he said were left-leaning.
Mr Berlusconi still faces possible indictment on charges of bribery and tax fraud.