Parathyroid hormone-related protein (PTHrP) expression is necessary for differentiation of mesenchymal lipofibroblasts, which induce epithelial type II (TII) cell differentiation, both of which are necessary for alveolarization. PTHrP deficiency may be associated with bronchopulmonary dysplasia (BPD), characterized by truncation of alveolarization among preterm infants. This is supported by the baboon model of BPD (failure of alveolarization) that manifests PTHrP deficiency. We provide evidence that TII cell PTHrP expression is downregulated by alveolar overdistension, resulting in the transdifferentiation of lipofibroblasts to myofibroblasts, characterized by progressive loss of PTHrP receptor expression and triglyceride content, and sequential upregulation of alpha-smooth muscle actin (alphaSMA), typifying fibrosis. PTHrP reverses the downregulation of the PTHrP receptor and upregulation of alphaSMA, reverting myofibroblasts to a lipofibroblast genotype. When TII cells are co-cultured with lipofibroblasts, they proliferate and differentiate, expressing surfactant protein-B; in contrast, TII cells co-cultured with myofibroblasts fail to develop, mimicking the failed alveolarization associated with BPD. Treatment of myofibroblasts with 15-deoxy-Delta 12, 14 prostaglandinJ(2) (PGJ(2)) stimulates ADRP expression, reconstituting the lipofibroblast phenotype. PGJ(2)-treated myofibroblasts promote TII cell growth and surfactant protein-B expression, indicating that failed alveolarization due to transdifferentiation is reversible. We conclude that alveolar overdistension can cause fibroblast transdifferentiation, resulting in failed alveolarization.