Human lungs contain unique cell populations in distal respiratory airways (RAs). These populations accumulate in patients with lung injury, chronic obstructive pulmonary disease (COPD) and idiopathic pulmonary fibrosis (IPF). Their lineage potentials and roles are unknown, however. As they are absent in rodents, deeper understanding of these cells requires a human in vitro model. Here we report the generation from human pluripotent stem cells (hPSCs) of expandable spheres (induced respiratory airway progenitors (iRAPs)) consisting of all RA-associated cell types. iRAPs could differentiate into type 1 (AT1) and type 2 alveolar (AT2) epithelial cells in defined conditions, showing that alveolar cells can be derived from RAs. iRAPs with deletion of HPS1, which causes pulmonary fibrosis in humans, display defects that are hallmarks of IPF, indicating involvement of intrinsic dysfunction of RA-associated cells in IPF. iRAPs thus provide a model to gain insight into human lung regeneration and into pathogenesis of IPF.