Idiopathic pulmonary fibrosis (IPF) is a progressive and incurable lung disease characterized by tissue scarring that disrupts gas exchange. Epithelial cell dysfunction, fibroblast activation, and excessive extracellular matrix deposition drive this pathology that ultimately leads to respiratory failure. Mechanistic studies have shown that repeated injury to alveolar epithelial cells initiates an aberrant wound-healing response in surrounding fibroblasts through secretion of mediators like transforming growth factor-β, yet the precise biological pathways contributing to disease progression are not fully understood. To better study these interactions there is a critical need for lung models that replicate the cellular heterogeneity, geometry, and biomechanics of the distal lung microenvironment. In this study, induced pluripotent stem cell-derived alveolar epithelial type II (iATII) cells and human pulmonary fibroblasts were arranged to replicate human lung micro-architecture and embedded in soft or stiff poly(ethylene glycol) norbornene (PEG-NB) hydrogels that recapitulated the mechanical properties of healthy and fibrotic lung tissue, respectively. The co-cultured cells were then exposed to pro-fibrotic biochemical cues, including inflammatory cytokines and growth factors. iATIIs and fibroblasts exhibited differentiation pathways and gene expression patterns consistent with trends observed during IPF progression in vivo. A design of experiments statistical analysis identified stiff hydrogels combined with pro-fibrotic biochemical cue exposure as the most effective condition for modeling fibrosis in vitro. Finally, treatment with Nintedanib, one of only two Food and Drug Administration (FDA)-approved drugs for IPF, was assessed. Treatment reduced fibroblast activation, as indicated by downregulation of key activation genes, and upregulated several epithelial genes. These findings demonstrate that human 3D co-culture models hold tremendous potential for advancing our understanding of IPF and identifying novel therapeutic targets.