Malcolm Turnbull has been elected as leader, 54-44, by his Liberal colleagues.
Tony Abbott has been dumped as Prime Minister, less than six hours after Malcolm Turnbull challenged for the leadership.
Mr Turnbull was elected on a majority of 54 votes to Mr Abbott's 44. There was one informal vote.
Julie Bishop has been elected as Deputy Leader, beating Kevin Andrews 70-30 votes.
Mr Abbott has been removed after around two years in the job, the latest Prime Minister to be removed by their party before their full term.
No elected Prime Minister has served a full term since John Howard, who lost government in 2007.
Addressing media after the ballot, Mr Turnbull said it had been "a very important day in the life of the nation".
"This has been a very important sobering experience today," he said.
"I'm very humbled by the great honour and responsibility that has been given to me today. We need to have in this country and we will have now, an economic vision, a leadership that explains the great challenges and opportunities that we face."
Mr Turnbull said he expected the parliament to serve its full term, with ministerial changes to be made after the end of the sitting week.
Addressing media before the ballot, Mr Turnbull said that "the Prime Minister has not been capable of providing the economic leadership our nation needs".
"We need a different style of leadership," he said.
"We need a style of leadership that explains those challenges and opportunities, explains the challenges and how to seize the opportunities. A style of leadership that respects the people's intelligence, that explains these complex issues and then sets out the course of action we believe we should take and makes a case for it.
"We need advocacy, not slogans. We need to respect the intelligence of the Australian people."
Mr Turnbull said the government had lost multiple Newspolls in a row, stating that "the people have made up their mind about Mr Abbott's leadership".
"There must be an end to policy on the run and captain's calls," he said.
"We need to be truly consultative with colleagues, members of Parliament, senators and the wider public. We need an open government, an open government that recognises that there is an enormous sum of wisdom both within our colleagues in this building and, of course, further afield."
Mr Turnbull will reportedly stick to current party policy on climate change and marriage equality.
This was the second move against Mr Abbott since February, when he won a party room ballot to avert a vote on the Liberal leadership.
The win now leaves Mr Turnbull responsible for negotiations with the Nationals.
Before the ballot, Nationals leader and deputy Prime Minister Warren Truss said Mr Abbott had been a "very inclusive leader".
"My Coalition agreement is with Tony Abbott," he said.
"While the leadership is a choice for the Liberals, any change would require a new Coalition agreement and a new message of support to the Governor-General from me."
Before the ballot, Opposition Leader Bill Shorten told media that changing the leader of the Liberal Party changes nothing.
"Malcolm Turnbull is right, that Australia has been going nowhere for the last two years with this chaotic, dysfunctional, divided Liberal Government," he said.
"... But Malcolm Turnbull is wrong when he says he is part of the solution.
"Australians know that Malcolm Turnbull is ambitious but he's ambitious for himself, not our nation. With Malcolm, it will always be about Malcolm. Australians rejected Malcolm Turnbull when he was Opposition Leader because he was out of touch and he was arrogant and he hasn't changed.
"Australia does not need another out of touch, arrogant, Liberal leader. Australia needs a change of government."
Before the ballot, a number of cabinet ministers had voiced support for Mr Abbott with Kevin Andrews describing him as a "fighter".
Treasurer Joe Hockey had also voiced support for Mr Andrews, stating "the PM has my absolute loyalty, as I have his".
"We cannot and we must not make the same mistakes that were made in the Rudd and Gillard years," he said.
"The Australian people deserve better."
Mr Hockey also dismissed some of Mr Turnbull's claims on the economy, stating that they were "completely unfounded".