Isl1 expression marks progenitor populations in developing embryos. In this study, we investigated the contribution of Isl1-expressing cells that utilize the β-catenin pathway to skeletal development. Inactivation of β-catenin in Isl1-expressing cells caused agenesis of the hindlimb skeleton and absence of the lower jaw (agnathia). In the hindlimb, Isl1-lineages broadly contributed to the mesenchyme; however, deletion of β-catenin in the Isl1-lineage caused cell death only in a discrete posterior domain of nascent hindlimb bud mesenchyme. We found that the loss of posterior mesenchyme, which gives rise to Shh-expressing posterior organizer tissue, caused loss of posterior gene expression and failure to expand chondrogenic precursor cells, leading to severe truncation of the hindlimb. In facial tissues, Isl1-expressing cells broadly contributed to facial epithelium. We found reduced nuclear β-catenin accumulation and loss of Fgf8 expression in mandibular epithelium of Isl1(-/-) embryos. Inactivating β-catenin in Isl1-expressing epithelium caused both loss of epithelial Fgf8 expression and death of mesenchymal cells in the mandibular arch without affecting epithelial proliferation and survival. These results suggest a Isl1→β-catenin→Fgf8 pathway that regulates mesenchymal survival and development of the lower jaw in the mandibular epithelium. By contrast, activating β-catenin signaling in Isl1-lineages caused activation of Fgf8 broadly in facial epithelium. Our results provide evidence that, despite its broad contribution to hindlimb mesenchyme and facial epithelium, the Isl1-β-catenin pathway regulates skeletal development of the hindlimb and lower jaw through discrete populations of cells that give rise to Shh-expressing posterior hindlimb mesenchyme and Fgf8-expressing mandibular epithelium.