The ability to generate lung and airway epithelial cells from human pluripotent stem cells (hPSCs) would have applications in regenerative medicine, modeling of lung disease, drug screening and studies of human lung development. We have established, based on developmental paradigms, a highly efficient method for directed differentiation of hPSCs into lung and airway epithelial cells. Long-term differentiation of hPSCs in vivo and in vitro yielded basal, goblet, Clara, ciliated, type I and type II alveolar epithelial cells. The type II alveolar epithelial cells were capable of surfactant protein-B uptake and stimulated surfactant release, providing evidence of specific function. Inhibiting or removing retinoic acid, Wnt and BMP—agonists to signaling pathways critical for early lung development in the mouse—recapitulated defects in corresponding genetic mouse knockouts. As this protocol generates most cell types of the respiratory system, it may be useful for deriving patient-specific therapeutic cells.