Resistance to a broad spectrum of structurally diverse chemotherapeutic drugs (multidrug resistance; MDR) is a major impediment to the treatment of cancer. One cause of MDR is the expression at the tumor cell surface of P-glycoprotein (Pgp), which functions as an ATP-powered multidrug efflux pump. Since Pgp interacts with its substrates after they partition into the lipid bilayer, changes in membrane physicochemical properties may have substantial effects on its functional activity. Various interactions between cholesterol and Pgp have been suggested, including a role for the protein in transbilayer movement of cholesterol. We have characterized several aspects of Pgp-cholesterol interactions, and found that some of the previously reported effects of cholesterol result from inhibition of Pgp ATPase activity by the cholesterol-extracting reagent, methyl-beta-cyclodextrin. The presence of cholesterol in the bilayer modulated the basal and drug-stimulated ATPase activity of reconstituted Pgp in a modest fashion. Both the ability of drugs to bind to the protein and the drug transport and phospholipid flippase functions of Pgp were also affected by cholesterol. The effects of cholesterol on drug binding affinity were unrelated to the size of the compound. Increasing cholesterol content greatly altered the partitioning of hydrophobic drug substrates into the membrane, which may account for some of the observed effects of cholesterol on Pgp-mediated drug transport. Pgp does not appear to mediate the flip-flop of a fluorescent cholesterol analogue across the bilayer. Cholesterol likely modulates Pgp function via effects on drug-membrane partitioning and changes in the local lipid environment of the protein.