Fibroblast-epithelial interactions were investigated in cells from late-gestation fetal rat lung. Fibroblasts from the pseudoglandular stage of lung development stimulated epithelial cell proliferation, whereas fibroblasts from the saccular stage promoted epithelial cell differentiation. The developmental switch from proliferation to differentiation seemed to be controlled by both cell types. Fibroblast-derived epithelial cell growth-promoting activity, evident in cells from the pseudoglandular period, decreased during development and almost disappeared in cells from the saccular stage. Interestingly, the response of epithelial cells to this growth-promoting activity declined with advancing gestational age as epithelial cells became more responsive to fibroblast-derived differentiation factor(s). Production of differentiation factor(s) by fibroblasts increased during the canalicular stage of lung development. Platelet-derived growth factor (PDGF) and low concentrations of transforming growth factor-beta (TGF-beta) stimulated epithelial cell proliferation. PDGF did not affect differentiation, whereas TGF-beta was inhibitory. Dependent on their proximity to the epithelium, two subpopulations of fibroblasts that differed in their ability to promote epithelial cell proliferation or differentiation were isolated. Fibroblasts in close proximity to the epithelium mainly produced differentiation factors, whereas more distant fibroblasts primarily stimulated proliferation.