In the olfactory bulb, lateral inhibition mediated by granule cells has been suggested to modulate the timing of mitral cell firing, thereby shaping the representation of input odorants. Current experimental techniques, however, do not enable a clear study of how the mitral-granule cell network sculpts odor inputs to represent odor information spatially and temporally. To address this critical step in the neural basis of odor recognition, we built a biophysical network model of mitral and granule cells, corresponding to 1/100th of the real system in the rat, and used direct experimental imaging data of glomeruli activated by various odors. The model allows the systematic investigation and generation of testable hypotheses of the functional mechanisms underlying odor representation in the olfactory bulb circuit. Specifically, we demonstrate that lateral inhibition emerges within the olfactory bulb network through recurrent dendrodendritic synapses when constrained by a range of balanced excitatory and inhibitory conductances. We find that the spatio-temporal dynamics of lateral inhibition plays a critical role in building the glomerular-related cell clusters observed in experiments, through the modulation of synaptic weights during odor training. Lateral inhibition also mediates the development of sparse and synchronized spiking patterns of mitral cells related to odor inputs within the network, with the frequency of these synchronized spiking patterns also modulated by the sniff cycle.