Playboy and visionary industrial genius Tony Stark, CEO of leading military defense contractor, Stark Industries, is in war-torn Kunar, Afghanistan with his friend and military liaison, Lieutenant Colonel James Rhodes to demonstrate the new "Jericho" missile.

While riding in a transport convoy, Stark is critically wounded in an ambush and held captive in a cave by the Ten Rings. An electromagnet built by fellow captive Ho Yinsen keeps the shrapnel that wounded Stark from reaching his heart and killing him. The Ten Rings leader, Raza offers Stark freedom in exchange Stark must build a Jericho missile for the group, but Stark and Yinsen agree that Raza will not keep his word.

While pretending to work on the missile, Stark and Yinsen secretly build a powerful electric generator called an Arc Reactor, to power Stark's electromagnet, and then they begin to build a powered suit of armor, designed by Stark, to help them escape. The Ten Rings attack the workshop when they discover Stark's plan, but Yinsen sacrifices himself to distract them while Stark's suit powers up.

Using the armored suit, Stark fights his way out of the cave to find a mortally wounded Yinsen, who reassures Stark and urges him to continue his escape and not waste his life. An enraged Stark leaves the cave, burns the terrorist's stockpile of Stark Industries produced weapons and flies away, only then to crash in the desert, destroying his suit.

After being rescued by Rhodes, Stark returns home and announces that his company will no longer manufacture weapons, having seen first hand the strife that his weapons had caused in the wrong hands. Obadiah Stane, his father's old partner and the company's manager, advises Stark that this may ruin Stark Industries and his father's legacy.

In his home workshop, Stark spends the next few months building an improved version of his suit, as well as a more powerful arc reactor for his chest. At Stark's first public appearance after his return, Christine Everhart informs him that Stark Industries weapons, including the Jericho missile, were recently delivered to the Ten Rings and are being used to attack Yinsen's home village. Stark confronts Stane about the weapons and learns that Stane is trying to replace him as head of the company.

Enraged, Stark dons his new armor and flies to Afghanistan, where he saves Gulmira, Yinsen's village. While flying home, Stark is engaged by two F-22 Raptors. He phones Rhodes and reveals his identity in an attempt to call off the attack. Meanwhile, the Ten Rings gathers the pieces of Stark's prototype suit. Raza meets with Stane and offers to exchange the suit with him, however, Stane has the group eliminated and takes the suit for himself. Returning to Stark Industries, Stane orders his scientists to have a new suit reverse engineered from the wreckage.

Seeking to find any other weapons delivered to the Ten Rings, Stark sends Pepper Potts to hack into the company computer system from Stane's office. She finds evidence of Stane supplying weapons to the terrorists but also discovers that Stane had originally hired the Ten Rings to kill Stark in Afghanistan, but the group reneged. Potts later meets with Phil Coulson of the Strategic Homeland Intervention, Enforcement and Logistics Division, a counter-terrorism agency, to inform him of Stane's activities.

Stane's scientists reveal that they cannot finish his suit as they cannot duplicate Stark's Arc Reactor. Instead, Stane ambushes Stark at his home, using a Sonic Taser to paralyze him and take his Arc Reactor. Left to die, Stark manages to crawl to his lab and saves himself by re-using his original arc reactor. Potts and several S.H.I.E.L.D. agents attempt to arrest Stane, but he dons his suit and attacks them. Stark fights Stane, but is outmatched without his new reactor to run his suit at full capacity.

Stark lures Stane atop the Stark Industries building and instructs Potts to overload the large Arc Reactor there. This unleashes a massive electrical surge that knocks Stane unconscious, causing him and his armor to fall into the exploding reactor, killing him. The next day, the press has dubbed the armored hero "Iron Man". Agent Coulson gives Stark a cover story to explain the events of the night and Stane's death. At a press conference, Stark begins giving the cover story, but then announces that he is Iron Man.

Afterwards, Nick Fury visits Stark at home, and, noting that Iron Man is not "the only superhero in the world", says he wants to discuss the Avengers Initiative.