The lozenge (lz) gene encodes a transcription factor involved in prepatterning photoreceptor precursors in the developing Drosophila eye. The central region of the predicted Lz protein product is homologous to AML1, a transcription factor associated with human leukemias, and to the Drosophila protein Runt. We show here that Lz plays a crucial role in governing the fate of two groups of cells that are born in a single round of mitosis in the larval eye disc. Lz helps define a subset of these cells as an equipotential group that is competent to respond to the Sevenless developmental signal. This is achieved by negative regulation of seven-up, a member of the steroid hormone receptor superfamily in these cells. In contrast, in a second group of cells, the Lz protein confers proper photoreceptor identity by positively regulating the homeo box gene Bar. Additionally, our genetic analysis suggests that Lz interacts with the Ras pathway to determine photoreceptor cell fate. This study suggests that the strategies involved in cell fate determination in the Drosophila eye are remarkably similar to those utilized during vertebrate hematopoietic development and require the coordinate action of growth factor and AML1-like pathways.