The story is set in Monstropolis, a 1930's retro city inhabited by monsters, and centers around Monsters, Inc., the city's power company. Monsters, Inc. sends its employees to children's bedrooms to scare the children, through teleportation doors set up on the work floor. The screams of children then generate electric power for the city. In addition, the monsters believe that human children themselves are toxic (part of the skill involved in scaring includes avoiding contact with the children). The chairman and chief executive officer of Monsters, Inc. is a crab-like monster called Henry J. Waternoose (James Coburn). The top scarer at Monsters, Inc. is James P. "Sulley" Sullivan (John Goodman), a furry, blue, behemoth-like giant who is partnered with the short, green, one-eyed Mike Wazowski (Billy Crystal).
The two of them are best friends and roommates. Sulley is a gentle and easy-going creature, while Mike is obsessed with his car and with marrying his girlfriend, the Medusa-like Celia Mae (Jennifer Tilly). Sulley's main rival as a scarer is the chameleon-like Randall Boggs (Steve Buscemi), who possesses the ability to change the color of his skin to match his surroundings, and is second only to Sulley in the scarer ranks.
As Sulley and Mike are going to work one day, their discussion reveals that the city is suffering a power shortage because children have become desensitized to fear by over-exposure to television, making screams harder to provoke. Just before they are about to leave after a long day, the secretary, the slug-like Roz, asks Mike to hand in his paperwork. Mike had forgotten about it, and leaves it to Sulley to fill up his papers and hand them in, since Mike is in a hurry to leave on a date with Celia. As Sulley reaches the work floor to find Mike's papers, he finds a lone door on the work floor after hours, which is a violation of policy.
After inspecting the door, Sulley discovers a toddler human girl (Mary Gibbs) behind it. Because Sulley lacks the access card required to open the door, he cannot return her home. Frightened, Sulley tries his best to hide the girl from coworkers, believing he could be blamed for her presence. After several misadventures, Sulley finally takes the girl to Mike, who is enjoying a romantic dinner with his girlfriend at a sushi restaurant. The girl escapes from Sulley's grip at the restaurant, creating havoc amongst the monsters, and triggering the CDA (Child Detection Agency) troops to take action; Mike and Sulley grab the girl and hasten home, trying to avoid the CDA's attention at all times.
The girl stays overnight at Mike and Sulley's flat and is soon named Boo, for her habit of saying "Boo!" to surprise Sulley. The two come to know she is not dangerous as thought, but still plan to return her to her world the next day to avoid trouble from the CDA. They disguise her as a monster and sneak her inside Monsters, Inc., where they lose and regain track of her on two or three accounts. Eventually, Mike is caught by Randall, who offers to return Boo's door to the work floor. When Sulley mistrusts Randall, Mike enters the door himself to prove its safety and is mistaken for Boo by Randall, who places him in a box and takes him to a room hidden in the basement of the scream factory. There, Mike and the film's viewers are shown a large vacuum-based device designed to drain energy from children, called a Scream Extractor. Sulley and Boo, who have followed Randall, distract him and free Mike from the machine, leaving Randall's assistant in his place.
Sulley decides to inform Waternoose of Randall's evil scheme, but is forced to participate in a scare demo to teach new scare recruits. Boo is frightened by Sulley's roar, and running away, she trips; the hood of her costume reveals that she is the escaped human child. Sulley, guilty, looks up at the images of the scare in action, revealing Boo's crying face. Sulley understands how children really feel when scared.
Mike quickly reports Randall's scheming to Waternoose before he can seize Boo. But it turns out that Waternoose is in favor of Randall's scheme. Because of the decline in productivity, he fears for the company's future, and sees Randall's machine as the only way of ensuring Monsters Inc's survival. Waternoose betrays Sulley and Mike, and exiles the two into the Himalayas through a one-way teleportation door.
The two stay with the Abominable Snowman (John Ratzenberger) at a cave until the Snowman tells Sulley of a village far below the mountain. After an argument with Mike, Sulley sneaks back to the monsters' world through a closet door in a child's bedroom in the village; Mike soon follows. The two confront Randall and attempt to rescue Boo from scream extractor. Mike, Sulley, and Boo then lead Randall on a chase through moving teleporation doors, before Randall seems to have the upper hand on Sulley. Boo, no longer afraid of Randall, attacks him. Then Mike and Sulley push Randall through a teleportation door that sends him to a remote motorhome in a Louisiana swamp, where he is beaten senseless with a shovel by the family living inside, who mistake him for an alligator. Mike and Sulley destroy the door Randall went through, thus ensuring that he doesn't return soon.
Upon returning to the scare floor, Mike distracts the CDA while Sulley and Boo run off with Boo's door. Waternoose, however, spots this and pursues them. Sulley lures Waternoose onto the company's scare rehearsal stage. At the stage, Sulley infuriates Waternoose to such an extent that Waternoose blurts out his heinous plans in a rage: "I'll kidnap a thousand children before I let this company die!". Waternoose's statement is caught on tape, and he is taken into custody by the CDA. It is also revealed that the secretary, Roz, was in fact the leader of the CDA and had been doing undercover work for the agency. Boo is soon sent home and her door is put through a wood chipper.
During his time with Boo, Sulley has learned that children's laughter is much better than screams at generating power. Using this revolutionary approach, Sulley is made the new chairman and CEO of Monsters, Inc. and the company is redefined. Now the monsters enter through the teleportation doors and make kids laugh; in this way, ample power is created for Monstropolis, thus ending the power shortages in the city. Meanwhile, Mike has secretly reassembled Boo's splintered door, and the only part missing from it is the wood chip that Sulley had salvaged as a memory of Boo. Mike shows this to Sulley, and Sulley puts the wood chip in place and the door becomes functional. Then, Sulley enters through the door to take one more peek inside. Boo is heard but not seen, and the movie ends with a surprised and pleased smile on Sulley's face.
At the end, several comical "out-takes" are shown where the movie's characters are portrayed as actors. These are also available on the 'bonus features' section of the DVD
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