Question

Does Microsoft Security Essentials replace Windows Defender?

Answer 1

Yes. Windows Defender protects against adware and spyware, while MSE does all that and more (protection from viruses, rootkits, etc).

MSE will actually disable Windows Defender to manage your PC's realtime protection. Also, from the Security Essentials Wikipedia page:

Microsoft Security Essentials (MSE) (Previously codenamed Morro) is a free antivirus software created by Microsoft that provides protection against viruses, spyware, rootkits, and trojans for Windows XP, Vista, and 7.

MSE replaces Windows Live OneCare — a subscription antivirus service — and Windows Defender, which only protects users from adware and spyware.