A comprehensive formulation of the differential absorption lidar (DIAL) methodology is presented that explicitly includes details of the spectral distributions of both the transmitted and the backscattered light. The method is important for high-accuracy water-vapor retrievals and in particular for temperature measurements. Probability estimates of the error that is due to Doppler-broadened Rayleigh scattering based on an extended experimental data set are presented, as is an analytical treatment of errors that are due to averaging in the nonlinear retrieval scheme. System performance requirements are derived that show that water-vapor retrievals with an accuracy of better than 5% and temperature retrievals with an accuracy of better than 1 K in the entire troposphere are feasible if the error that results from Rayleigh-Doppler correction can be avoided. A modification of the DIAL technique, high-spectral-resolution DIAL avoids errors that are due to Doppler-broadened Rayleigh backscatter and permits simultaneous water-vapor and wind measurements with the same system.