The proper development of Meckel's cartilage is critical for craniofacial skeletogenesis, because it serves as the primordium for the formation of mandible, malleus, incus, and sphenomandibular ligament. Cranial neural crest (CNC) cells contribute significantly to the formation of Meckel's cartilage. Members of the transforming growth factor beta (TGF-β) family control the proliferation and differentiation of CNC cells during craniofacial skeletogenesis. TGF-β signaling is transduced from the cell membrane to the nucleus by means of specific type I and type II receptors and phosphorylated Smad proteins. Here we demonstrate that application of TGF-β promotes chondrogenesis by specifically increasing proliferation of CNC-derived chondrocytes and production of extracellular matrix. To understand the molecular regulation of TGF-β signaling, we have examined the biological function of both TGF-β receptor-regulated and inhibitory Smads during Meckel's cartilage development. The expression patterns of Smad2, 3, and 7 are identical to the ones of endogenous TGF-β and its cognate receptors during Meckel's cartilage development, establishing the potential that these intracellular signaling Smads may regulate TGF-β-mediated chondrogenesis. Functional haploinsufficiency of Smad2 delays TGF-β–mediated Meckel's cartilage development. Overproduction of Smad7 severely inhibits Meckel's cartilage formation, indicating a negative feedback on TGF-β signaling by inhibitory Smad is critical in orchestrating TGF-β–mediated gene regulation during embryonic chondrogenesis. The effectiveness of TGF-β signaling is highly sensitive to the level of Smad gene expression. © 2002 Wiley-Liss, Inc.