The induction, growth, and differentiation of epithelial lung buds are regulated by the interaction of signals between the lung epithelium and its surrounding mesenchyme. Fibroblast growth factor-10 (FGF-10), which is expressed in the mesenchyme near the distal tips, and bone morphogenetic protein 4 (BMP4), which is expressed in the most distal regions of the epithelium, are important molecules in lung morphogenesis. In the present study, we used two in vitro systems to examine the induction, growth, and differentiation of lung epithelium. Transfilter cultures were used to determine the effect of diffusible factors from the distal lung mesenchyme (LgM) on epithelial branching, and FGF-10 bead cultures were used to ascertain the effect of a high local concentration of a single diffusible molecule on the epithelium. Embryonic tracheal epithelium (TrE) was induced to grow in both culture systems and to express the distal epithelial marker surfactant protein C at the tips nearest the diffusible protein source. TrE cultured on the opposite side of a filter to LgM branched in a pattern resembling intact lungs, whereas TrE cultured in apposition to an FGF-10 bead resembled a single elongating epithelial bud. Examination of the role of BMP4 on lung bud morphogenesis revealed that BMP4 signaling suppressed expression of the proximal epithelial genes Ccsp and Foxj1 in both types of culture and upregulated the expression of Sprouty 2 in TrE cultured with an FGF-10 bead. Antagonizing BMP signaling with Noggin, however, increased expression of both Ccsp and Foxj1.