There are three aspects of dialogue that require attention during an edit: paragraphing, balance of exposition and dialogue, and creating real conversations.
There are many rules about paragraphing, e.g. one topic per paragraph. Here the focus is how to include dialogue.
Any time someone new speaks, you should start a new paragraph.
If a paragraph is all about one character’s actions and/or thoughts, his/her dialogue could remain within that paragraph.
It’s important, though, not to bury dialogue within a long paragraph. So, you might decide to split the paragraph.
The aim should be to end the paragraph at a point that indicates to the reader it’s time to pause and absorb what’s gone before, before proceeding to the next paragraph.
BALANCING EXPOSITION WITH DIALOGUE
A story of all exposition runs the risk of boring the reader. Too much dialogue and the reader might only get to know the characters, not the setting.
The mix doesn’t need to be half and half; what works best depends on what kind of story is being told.
The aim should not be to reproduce, verbatim, an exchange between characters that you might have overheard or imagined.
People tend to talk in note form, quite differently from how they write a letter or give a report. They might also use ‘um’ and ‘er’ a lot, but this doesn’t need to be reproduced in your dialogue, unless you particularly want to portray a character as being nervous, or as a ditherer.
In real life, when people argue, they often say something without taking into account what has just been said to them. There can be a barrage of insults and only when the heat has gone, and they are actually listening, do they make any progress.
With written material, the reader is ‘listening’ to everything that is being said; so if a response demonstrates the person who spoke was not listening, that’s fine; it simply shows there’s an argument in progress.
Realistic conversation might be tweaked to good effect. For example, relationships between pairs of people can be suggested (shown rather than told) by the way in which characters refer to one another – even if you’ve never heard someone do that in real life.