Due to slow business at the hardware store, Howard Cunningham decides to rent out the adjoining upstairs attic/apartment as a way to make more money. Fonzie brings his grandmother over to rent it, but she hates it. While his dad helps her down the outside steps, Richie talks Fonzie into moving in instead, much to the horror of Howard who still considers Fonzie a "hood" and nothing but trouble. (He nearly chokes Richie!) Will these two very different backgrounds be able to co-exist?
Surgery fixes the Fonz's injured knee but the Cunningham's coddling and his fear that pain will make him appear "uncool" keeps him lying on the couch, until Richie resorts to extreme measures to get Fearless Fonzarelli walking again.
To help secure a lucrative business deal for Cunningham Hardware, Howard asks Richie to take his client's daughter out on a date. Problem is, Richie already has a date ... but then he learns that Potsie doesn't.
Richie is continually harassed by a pair of local hoodlums named Frankie and Rocco. When they humiliate him during in front of his girlfriend at Arnold's, Richie turns to Fonzie for advice in turning the tables on his foes. It all leads to his enrollment in a jujitsu class.
Officer Kirk promises to forgive Howard Cunningham's parking tickets and allow a loading zone space in front of his hardware store, if Howard can convince the Fonz (who is given a temporary Special Police appointment) to stop his old gang, the Falcons, from rumbling with their rivals, the Dragons.
1950's racial prejudice and stereotyping are explored when most of their friends refuse to attend the Cunningham's Hawaiian luau after finding out that Richie's band's new drummer and his date are black.
Marion wants to join a dance contest but Howard and the kids think it's ridiculous. But she decides to enter with Fonzie and they spend their free time practicing. When she acts strangely because she's keeping it a secret from everybody, Howard wonders what's going on. And when Arnold who knows about it let's it slip that Marion is seeing someone else, Howard follows her. And when he sees her with Fonzie he loses it.
In a sneaky scheme to widen their dating pool, Richie, Potsie and Ralph stage a bogus beauty contest, planning to rig the vote to insure that a ringer provided by the Fonz will win but won't accept the promised fabulous prizes the boys can't afford and never intend to award.