The game begins with Jak and Daxter being banished into the Wasteland by the tyrannical Count Veger for supposed crimes against Haven City. Ashelin, who opposes the banishment, gives Jak a beacon before she leaves and tells him to "stay alive". As they travel through the desert, flashbacks reveal that Haven City is at war between the Freedom League and the surviving Metal Heads and their allies, the KG Death Bots. The Palace is then destroyed by an unknown force. As Jak, Daxter, and Pecker lose consciousness, they are rescued by a group of desert-dwellers, who take them back to Spargus City.

Waking up in Spargus, the King, Damas, says that Jak must earn his place in the civilization by proving himself as a warrior in both the Arena challenges and by serving the city, who his "life now belongs to" for being rescued. His missions involve recovering artifacts after sandstorms, racing for both buggies and Leaper lizards for upgrades, Eco crystals and buggies, catching Kanga rats upon a Leaper lizard, and several other odd jobs in the oasis city. Most important among these events is that Jak is bestowed Light Eco abilities to balance the darkness within, granted to him at the Precursor temple by an oracle who believes that Jak is the last hope for the civilization. These powers include time-slowing abilities, healing powers, shield abilities, and even flight. Along the way, Jak befriends the Precursor Monk, Seem, and a buggy garage owner, Kliever – who initially dislike him until he gains their trust over time. During one of Damas' missions into the desert, Jak is found by Ashelin, who reveals that she knew Damas would find him since she knew he would check his old beacons. She refuses to tell him how she knows Damas and then begs Jak to come back to Haven City to defend it from the Metal Heads and the new Krimzon Guard Deathbots. Still embittered about being exiled, he refuses to return. Ashelin leaves him, but later, after finding out what the evil Count Veger has in store for his friends, Jak changes his mind and makes the journey via transport to Haven City. Jak and Daxter help reunite the resistance in Haven, who is divided due to barriers put up by enemies, and give them hope that they can beat back the Metal Heads and Deathbots.