The first scene with the jitterbug contest I find very difficult to place. I have thought about it alot and have changed my opinion about it several times. So this explanation isn't most likely to be my final interpretation. I just want to elaborate on it.
First of all I think it's important to keep in mind that I view the film as dream-fantasy-reality, where each segment is getting closer to the truth on it's own as well as the segment as a whole being a step closer to reality.
Secondly, I'm of the opinion that Diane has been abused by her father (and mother is complicit by covering up) and that Diane has repressed the image of her parents and replaced it by that of her grant parents.
The jitterbug contest does not take place in the dream, because we see Diane getting to bed after this scene. What than are we to make of it? Did it realy happen or is it also part of Diane's fantasy? In my opinion there are only 3 options:
1/ It realy did happen the way Diane remembers it.
2/ It realy did happen but NOT the way Diane remembers it.
3/ It did NOT happen and is part of Diane's fantasy.
1.
Let's assume it did take place and Diane realy did win it. How are we to explain than the difficult appearance of her grant parents? Is it because she wanted them there, but that they were already dead? Or because in reality it were her parents who were there and Diane isn't fully able to place the false image of her grand parents at that scene? Both are plausible, but this approach has one fatal flaw: it doesn't fit the plotstructure of the movie. In the second segment, her fantasy, Diane mentions this jitterbug contest, but it seems like she's almost ashamed of it in the company of the important people in Hollywood. It seems like such a little event.
The point is: what is the change of this event in reality? We know that in the dream things are more detached from reality than in her fantasy. Still, the jitterbug contest isn't part of the dream. So, when we assume it is a big happening in Diane's life, while in the fantasy it is a small thing, what should we make of it in reality?
2.
When Diane did enter a jitterbug contest and even win it, but she has glorified her memory of it, what are we to make of it then? This approach is more plausible, because we know Diane has a tendency to picture things way more colorful than they in reality were.
When this scene is indeed a glorified picture, we certainly can explain the difficulty of picturing the grant parents. The scene itself is not real or at least not a real representation of what happened, so the grant parents do not fit this picture. I'm of the opinion that the grant parents of Diane were already dead by this time (she looks at least 16 in this scene), because the abuse probably started earlier. Would her grant parents be alive, would Diane not have told them? Furthermore, when we assume that Diane has replaced the image of her parents with that of her grant parents, we can conclude that Diane realy pictures her parents in this scene. But...she does not want her parents, because she hates them. Maybe that's why she is having difficulty placing them / her grant parents there.
So, when we conclude that this scene is a distorted memory of reality in Diane, we can follow this distortion through the fantasy, where Diane is ashamed of this jitterbug contest, but...what would this mean for reality? From a glorious moment to a very little moment to...what? To perhaps Diane not winning the contest at all? That would be a logical route within her dream and fantasy to reality. There are still little things about this sequence that makes this approach a little awkward.
3.
What if this contest didn't happen at all? That would also explain the difficulty Diane has placing her parents / grant parents at the scene. Let's explore the logical deductions from and clues for this assumption.
a. If it did not happen, that would mean that Diane made it all up. Why? A reason could be to lift herself up from the misery of abuse or to give herself a boost of self esteem. We can assume that it would not be a consciously created fantasy, but one which is automatically born out of her misery. We know that Diane had the tendency to escape into fantasy and her way was to loose herself into the magic of Hollywood and literally to escape to Hollywood itself.
b. We do not see Diane dance herself; we only get to see her carrying the prize and step into the foreground. She does NOT participate. It's like she has seen a contest on television and placed herself in it.
c. Why a jitterbug contest? When we look at aunt Ruth and conclude that Diane based her on Rita Hayworth, an actress she probably had seen many times on tv or in theatres and which she probably adored. Hayworth was a star in the 40-ies and 50-ies, exactly the time in which the jitterbug was popular. Could it be that Diane had a vision of herself within that time frame, next to Rita Hayworth, and assumed she won first prize?
d. This approach fits perfectly within the structure of the plot (dream-fantasy-reality) of the movie. From a highpoint in Diane's life to a little occasion in her fantasy to nothing at all in reality.
e. It also fits perfectly within the structure of the film itself. The jitterbug scene represents Diane's biggest fantasy lie; an occasion that did not take place and an achievement she did not earn. The end of the movie represents the bitter reality in Diane's life and that's her suicide. The juxtaposition is than: ultimate fantasy to ultimate reality.
f. A final clue to the jitterbug scene not being real would be the blending of the characters in Diane's fantasy after her suicide. All these characters were part of Diane's fantasy like the Bum, Rita and Camilla. But...we also see the image of a young Diane like we have seen in the jitterbug scene. So, is she, like the rest of the characters in that sequence fictitious? You can assume of course, that after Diane had won the contest, she began to create her fantasy, because after that highpoint in her life she only went downwards. Still, I find that approach not convincing, because the characters do NOT blend into this image of Betty but into Diane, including this image self. So, to me that's a strong clue that this image of herself is indeed fictitious and that the contest did NOT take place.
Finally I want to mention something I've read on this forum. I do not recall it myself, but apparently there is something being said in Spanish before the jitterbug-contest. Translated it is this: "This is something new." That could mean two things and in my opinion support the 3rd approach.
1. "This is something new" can mean that the sequence, the jitterbug-scene is new in Diane's life, because it did not take place.
2. It can also mean, that the jitterbug itself was something new and that would mean that this sequence plays at the start of the popularity of the jitterbug (in the 1950-ies) and this would definately suggest that this is a fantasy of Diane that never took place.

