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At the start of the movie and from time to time during the movie the 9-year-old boy Eric (Zach Mills) is shown with a book telling the story.

Eccentric 243-year-old Mr. Magorium (Dustin Hoffman) owns and manages a magical toyshop. The shop has many quirks, including sentient toys and a doorknob that, when rotated, changes the interior of a magic room. Magorium's store manager is the young woman Molly Mahoney (Natalie Portman), who is an aspiring pianist and has plans to quit the store and start a career in music. Mahoney is, apparently, Eric's only friend, as shown by their first on-screen conversation.

Unexpectedly, Mr. Magorium announces that although he is not ill, it is time for him to "leave", and as a surprise, he gives the shop to Mahoney. She does not understand, but Eric explains to her that he seems to mean that he is going to heaven. She urges Magorium to stay and struggles with self-doubt.

As a preparation for his "departure", Magorium hires accountant Henry Weston (Jason Bateman), after an interview where he demonstrates knowledge of Fibonacci numbers. He calls him the "mutant". His task is to sort out the neglected paper work of the shop. Weston is not popular with children and, when Eric first tries to become friends with him, says that he "never stops working". Mahoney does not like Weston's lack of humour or his disbelief in the shop's magic. As a result of the stressful events, the store itself has a tantrum, turning grey and forcing the customers to leave.

Eric, who often plays and works in the store and is urged to find friends by his mother, eventually befriends Weston and shows him the enormous hat collection in his room, to the discomfort of his mother. Meanwhile, worried by Magorium's plan to "leave", Mahoney rushes him to the hospital, where doctors confirm that he requires observation when Magorium explains his age and position. He is quickly released, as nothing is physically wrong with him. Mahoney attempts to prevent his departure by showing him life's joys, but Magorium does not change his mind about "leaving". After a heartfelt talk, Mahoney leaves in tears and Magorium throws his last paper airplane, peacefully dying as the airplane flies around the room. Many children and adults alike crowd the cemetery to witness his funeral.

Mahoney, believing herself to be unworthy of the store, offers it for sale. Eric regrets this very much and approaches Weston with a "business proposal"

he is willing to invest his savings and pocket-money in the shop. Though he refuses, Weston sees that Mahoney is making a mistake, and tries to persuade her against selling the store. While doing so, he witnesses for himself the store's magic and is at last convinced of it. The shop itself, distressed by Magorium's death and the upcoming sale, is delighted and colourfully revived as Mahoney finally takes her position as manager and unlocks her creative potential.