Although retinoic acid (RA) has been shown to be critical for lung development, little is known about when RA is required and the role of individual RA receptors (RAR) in this process. Previously reported data from an RA responsive element RARE-lacZ reporter mouse show that when epithelial tubules are branching and differentiating RA signaling becomes markedly down-regulated in the epithelium. It is unclear why this down-regulation occurs and what role it might play in the developing lung. Here we analyze the effects of preventing potential progenitors of the distal lung from turning off RA signaling by locally expressing constitutively activated RARalpha or RARbeta chimeric receptors (RARVP16) in branching airways of transgenic mice. Continued RA activation resulted in lung immaturity in both cases, but the phenotypes were remarkably different. RARalphaVP16 lungs did not expand to form saccules or morphologically identifiable type I cells. High levels of surfactant protein C (Sp-C), thyroid transcription factor-1 (Ttf1), and Gata6, but not Sp-A or Sp-B in the epithelium at birth suggested that in these lungs differentiation was arrested at an early stage. These alterations were not observed in RARbetaVP16 lungs, which showed relatively less severe changes. Our data suggest a model in which activation of RAR signaling at the onset of lung development establishes an initial program that assigns distal cell fate to the prospective lung epithelium. Down-regulation of RA signaling, however, is required to allow completion of later steps of this differentiation program that ultimately form mature type I and II cells.