On the morning of February 9, 1988, while being chased by Detective Mike Norris (Chris Sarandon), Charles Lee Ray, a serial killer known as "The Lakeshore Strangler" (Brad Dourif), is shot and mortally wounded. Before dying, Charles takes cover inside a toy store, finding boxes of "Good Guy" dolls and uses a voodoo ritual to transfer his soul into one of the dolls. The store is then struck by lightning and it burns to the ground.
Later that morning, 6-year-old Andy Barclay (Alex Vincent) tells his widowed mother Karen Barclay (Catherine Hicks) that he wants a Good Guy doll for his birthday after watching a TV commercial for it. Unable to afford the full price, Karen buys a stolen doll from a street peddler, which is the same doll Charles Lee Ray had earlier transferred his soul into.
That night, as Andy is playing with the doll (who has introduced himself as "Chucky" through the talking feature of the doll), Karen's friend, Maggie Peterson (Dinah Manoff), who is babysitting Andy, scolds him for turning on the evening news and placing Chucky in front of the TV. When Andy tries to tell Maggie that he did not put Chucky in front of the TV, she doesn't believe him. Maggie is then viciously struck with a toy hammer and falls out of the apartment window, falling several stories to her death. The killer's identity is left ambiguous. Andy, when questioned, insists that Chucky has revealed himself to be alive and that he killed Maggie, though he defends Chucky's decision by stating that Chucky told him that "Maggie was a real bitch" and that she "got what she deserved".
The next day, Andy, apparently upon Chucky's request, visits the house of Eddie Caputo (Neil Giuntoli), Charles Lee Ray's accomplice, who had betrayed him and led him to his death. Chucky is revealed as being alive. He sneaks into Eddie's house and blows out the pilot light on the stove and turns up the gas; Eddie, in panicked self-defense, fires his gun and the house explodes, killing him.
Later, authorities place Andy in a psychiatric ward after he is found near the crime scene. Karen believes the doll to be the culprit after she realizes that his batteries had never been put in and she threatens to throw him into the fireplace unless he reveals himself to her. Chucky comes alive in her hands, bites her and runs out of the apartment. She contacts Detective Norris, who is now investigating Maggie's death. Although he initially doubts her story, the homeless man who sold Karen the doll confirms that he retrieved it from the burnt down toy store where Charles Lee Ray was killed. Norris becomes a firm believer after he is attacked by Chucky in his car and survives only by shooting the doll.
Chucky later meets with John Simonsen (aka Dr. Death), his voodoo instructor from years past, and asks why his gunshot wound bled. John, under torture via voodoo doll, informs him that his body is slowly conforming to that of a human's and that he will soon be trapped in the body if he does not transfer his soul into the body of the first person he revealed himself to, which is Andy. Offhandedly remarking that he will "get to be six years old again," Chucky stabs the voodoo doll and leaves John to die. Karen and Detective Norris, following leads from Charles Lee Ray's case file, find John as he lay dying and receive instructions on how to kill Chucky; although Chucky is a doll, his heart is fully human and vulnerable to fatal injury.
Andy escapes from the psychiatric unit and Chucky brutally kills the head doctor (Jack Colvin) through electrocution in the process. The authorities believe Andy killed the doctor while escaping. Mike and Karen rush back to the apartment hoping that Andy is there. Chucky reaches the apartment where Andy is and knocks him unconscious with a baseball bat to steal his soul. After a prolonged struggle, Karen throws Chucky into the fireplace and Andy lights Chucky on fire after he throws the match in the fireplace.
Andy and Karen, thinking Chucky is dead, go to help the injured Mike Norris. After Andy gets the first aid kit from under the sink, he discovers Chucky is gone. Very burnt but alive, Chucky chases after Andy and Karen, who barricade themselves in the bedroom; Karen shoots him several times, missing his heart, but scattering his head, an arm and a leg in the hallway. Chucky starts stabbing the doors with a knife so that Karen will open it. After Norris' partner, Jack Santos, arrives, the scattered doll parts attempt to attack at the instructions of Chucky's screaming, severed head. Karen, remembering John's last words, tells Mike to shoot Chucky in the heart. Norris does so and makes a direct hit, killing Chucky (Charles Lee Ray) again.
An ambulance arrives to take Mike to the hospital. Karen and Jack help Mike walk out the door, but Andy stays and looks over the remains of Chucky. Karen returns and leads Andy out of the room and turns off the lights. Andy turns to look at Chucky one last time before leaving.