The Sonic Hedgehog (Shh) pathway is responsible for critical patterning events early in development and for regulating the delicate balance between proliferation and differentiation in the developing and adult vertebrate brain. Currently, our knowledge of the potential role of Shh in regulating neural stem cells (NSC) is largely derived from analyses of the mammalian forebrain, but for dorsal midbrain development it is mostly unknown. For a detailed understanding of the role of Shh pathway for midbrain development in vivo, we took advantage of mouse embryos with cell autonomously activated Hedgehog (Hh) signaling in a conditional Patched 1 (Ptc1) mutant mouse model. This animal model shows an extensive embryonic tectal hypertrophy as a result of Hh pathway activation. In order to reveal the cellular and molecular origin of this in vivo phenotype, we established a novel culture system to evaluate neurospheres (nsps) viability, proliferation and differentiation. By recreating the three-dimensional (3-D) microenvironment we highlight the pivotal role of endogenous Shh in maintaining the stem cell potential of tectal radial glial cells (RGC) and progenitors by modulating their Ptc1 expression. We demonstrate that during late embryogenesis Shh enhances proliferation of NSC, whereas blockage of endogenous Shh signaling using cyclopamine, a potent Hh pathway inhibitor, produces the opposite effect. We propose that canonical Shh signaling plays a central role in the control of NSC behavior in the developing dorsal midbrain by acting as a niche factor by partially mediating the response of NSC to epidermal growth factor (EGF) and fibroblast growth factor (FGF) signaling. We conclude that endogenous Shh signaling is a critical mechanism regulating the proliferation of stem cell lineages in the embryonic dorsal tissue.