Having never really grown up, Buddy often acts like he's still seven years old.
And despite his well meaning intentions he often causes trouble when trying to understand the human world, after growing up with Santa and his elves.
One Christmas Eve, during a stop at an orphanage, a baby boy, captivated by the sight of a teddy bear, crawls into Santa Claus's (Ed Asner) sack of toys. Santa unknowingly takes the boy back to the North Pole, and when discovered, is named Buddy because of his "Little Buddy" branded diaper. Papa Elf (Bob Newhart) volunteers to raise him.
Buddy (Will Ferrell) grows up at the North Pole and is unaware of his humanity. Papa Elf makes him his apprentice and explains that he repairs the "Kringle 3000, 500 Reindeer-Power" jet engine on Santa's sleigh, which he invented in the 1960's when the Christmas spirit that powers the sleigh started declining after people started to stop believing in Santa Claus, forcing him to build the engine to assist Santa. Due to his being a human in an environment designed for the North Pole elves, Buddy is uncomfortably bigger than the elves, and is unable to use the items utilized by them. His toy making skills are comparatively inferior and he is unable to keep up with the elves' high quotas, and despite the elves' assurances that he's just "special", is demoted to a demeaning job testing toys. While working, he overhears a conversation in which one of the elves mentions that Buddy is in fact a human. Papa Elf reveals that Buddy was born to Walter Hobbs (James Caan) and Susan Wells and given up for adoption, and that Walter never knew of his existence. He explains how Susan later died and that Walter now works at a children's book company in New York City. Buddy is convinced by Leon the Snowman (Leon Redbone) to go to New York to find his father. Prior to leaving, Santa informs him that his father, Walter, is on the naughty list due to his greed and selfishness. This is a huge shock and upset to Buddy.
Upon arriving in New York City, Buddy fails to comprehend several aspects of the human world, crossing the street at the wrong time, chewing discarded gum from a subway banister (despite Santa's warning), and taking a coffee shop's claim to have the "world's best cup of coffee" literally and running inside to congratulate them. Eventually, he finds his father in his office in the Empire State Building. Walter initially lets him in, thinking Buddy is sending him a Christmas gram but when Buddy tells him about Susan Wells, an incredulous Walter has him removed by security. Taking the guards' sarcastic advice, Buddy goes to Gimbels, where the manager (Faizon Love), mistakes him for a store employee. In the store's Santa Land, Buddy sees Jovie (Zooey Deschanel), a Gimbels employee to whom he is instantly attracted. Upon learning that Santa will be arriving the next day, Buddy sneaks into the store after hours and spends the night giving Santa Land a makeover, complete with Lego models, pillow stuffing as snow, fancy decorations, and a giant LED sign.
When the store Santa (Artie Lange) arrives, Buddy is shocked to discover that it is not the real Santa Claus, and the two have a destructive brawl after Buddy rips off the man's fake beard to expose him as an impostor. As a result, Buddy is banned from the store and sentenced to 24 hours in jail. Walter gets a call from the police and, after reluctantly bailing Buddy out, takes him to a pediatrician (Jon Favreau) for a DNA test, which confirms that Buddy is Walter's biological son. Although Walter is still incredulous seeing Buddy as insane, he is pressured by the doctor into taking him home to meet his stepmother, Emily (Mary Steenburgen) and 12-year-old half-brother Michael (Daniel Tay). Walter and Michael are put off by Buddy's childlike behavior (such as slathering his spaghetti in maple syrup and M&Ms and not seeming to understand that neither of them are interested in playing with him), but Emily insists that they take care of him until he "recovers".
Buddy eventually befriends Michael after single-handedly helping him defeat a gang of bullies in a snowball fight with deadly accuracy, and Michael encourages Buddy to ask Jovie out. Meanwhile, Walter learns from his boss Mr. Greenway (Michael Lerner) that his company is failing after publishing the flop "The Puppy and the Pigeon" with two missing pages, after Walter had refused to reprint the book citing the high cost of doing so. His boss said that the next big pitch for a next book idea will be taking place on Christmas Eve and expects Walter to be there or he will be fired. Although not wanting to, he accepts. The next day, after some pressure from Emily, Walter reluctantly takes Buddy to work with him and sends him down to the mailroom so he cannot be disturbed. However, he accidentally becomes drunk after mistaking a co-worker's whiskey for syrup and throws an outrageous party, which causes the mailroom supervisor to interrupt a phone conversation between Walter and best-selling children's author Miles Finch (Peter Dinklage), whom Walter wants to hire in order to save his company. Buddy goes on a date with Jovie and manages to win her over with his child-like personality. Meanwhile, Miles Finch arrives at Walter's company and begins to share some of his suggestions for book covers, but Buddy interrupts the meeting to tell his dad about his newfound love. Buddy mistakes Finch for an elf because he is short. Finch brushes it off at first, but becomes increasingly annoyed with Buddy's attempts to find out how he had managed to leave Santa's Workshop, to which Buddy remarks that Finch is an "angry elf". Finch loses his temper and attacks Buddy before storming out of the conference room, despite Walter's attempt to explain Buddy's misunderstanding. Furious that the one chance of saving his company has been ruined, Walter yells at Buddy, saying even though he is his son, he wants him out of his life. Deeply saddened and hurt, Buddy returns home and, after writing a message on an etch-a-sketch apologizing for ruining everyone's lives, leaves Walter's apartment.
Back at the office, Walter's associates reveal a notebook Finch left behind in the conference room. Discovering that it is filled with excellent ideas for children's books, Walter excitedly tells them to get a storyboard ready. Meanwhile, Michael finds Buddy's note, and bursts in on Walter's meeting with Greenway to frantically tell him that Buddy is gone. After Michael points out that Walter seems to care more about himself than his family, Walter asks Greenway to reschedule, but when he callously refuses, Walter and Michael tell him "up yours" before leaving. As a result, Greenway fires Walter. Buddy, while lamenting his situation, sees Santa's sleigh crash in Central Park, which attracts the attention of various news stations, the NYPD, and fellow New Yorkers. When Buddy finds Santa, he explains that the sleigh's engine had broken off, and that the last bit of Christmas spirit which powers the sleigh has faded as well. Walter apologizes for having hurt Buddy and accepts him as his son. Buddy then takes them to meet Santa, who reveals to them that believing in him can make his sleigh fly. Getting an idea, Michael steals Santa's list and reads it in front of the TV cameras set up outside the park so that people all over New York City can believe in him, while the Central Park Rangers, who never forgave Santa for putting them on the naughty list, chase his sleigh as Buddy tries to reattach the engine.
Jovie, who was in the crowd after seeing the events on TV, manages to overcome her shyness and gets the sleigh back in the air by the power of Christmas spirit when she leads the crowd of people in singing "Santa Claus Is Coming to Town" on live TV, recalling Buddy's statement; "The best way to spread Christmas cheer is singing loud for all to hear." However, Santa is still unable to fully power the sleigh. Walter, who was mouthing the words, is convinced by Michael to overcome his lack of Christmas spirit and starts singing for real. This allows the sleigh to fly higher without the engine, as the Christmas Spirit has been restored. The TV cameras are unable to capture Santa's sleigh as the news lady is in shock, so the world's collective Christmas Spirit is safe.
By the next Christmas, Walter has started his own publishing company with the first best-selling book released titled Elf, an account of Buddy's adventures written and illustrated by Buddy himself. Sometime later, Buddy and Jovie have a daughter named Susie, named after Buddy's now-deceased biological mother. During the film's closure, the family visits Papa Elf at the North Pole.