Tissue‐resident macrophages (MΦ_TR) originate from at least two distinct waves of erythro‐myeloid progenitors (EMP) arising in the yolk sac (YS) at E7.5 and E8.5 with the latter going through a liver monocyte intermediate. The relative potential of these precursors in determining development and functional capacity of MΦ_TR remains unclear. Here, we studied development of alveolar macrophages (AM) after single and competitive transplantation of different precursors from YS, fetal liver, and fetal lung into neonatal Csf2ra^−/− mice, which lack endogenous AM. Fetal monocytes, promoted by Myb, outcompeted primitive MΦ (pMΦ) in empty AM niches and preferentially developed to mature AM, which is associated with enhanced mitochondrial respiratory and glycolytic capacity and repression of the transcription factors c‐Maf and MafB. Interestingly, AM derived from pMΦ failed to efficiently clear alveolar proteinosis and protect from fatal lung failure following influenza virus infection. Thus, our data demonstrate superior developmental and functional capacity of fetal monocytes over pMΦ in AM development and underlying mechanisms explaining replacement of pMΦ in fetal tissues.