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The main narrative is introduced using a frame story in which most of the plot is presented as a flashback, as told by the protagonist, Francis (one of the earliest examples of a frame story in film).
Francis (Friedrich Fehér) and an elderly companion are sharing stories when a seemingly distracted woman, Jane (Lil Dagover), passes by. Francis calls her his betrothed and narrates an interesting tale that he and Jane share.
Francis begins his story with himself and his friend Alan (Hans Heinrich von Twardowski), who are both good-naturedly competing to be married to the lovely Jane. The two friends visit a carnival in their German mountain village of Holstenwall. They encounter the captivating Dr. Caligari (Werner Krauss) and a near-silent somnambulist, Cesare (Conrad Veidt), whom the doctor keeps asleep in a coffin-like cabinet, controls hypnotically, and is displaying as an attraction. Caligari hawks that Cesare's continuous sleeping state allows him to know the answer to any question about the future. When Alan asks Cesare how long he shall live, then Cesare bluntly replies that Alan shall die at dawn — a prophecy which is fulfilled. Alan's violent death at the hands of some shadowy figure becomes the most recent in a series of mysterious murders in Holstenwall.
Francis, along with Jane (whom he is now officially engaged to), investigates Caligari and Cesare, which eventually results in Caligari's order for Cesare to murder Jane. Cesare does so nearly, revealing to Francis the almost certain connection of Cesare and his master Caligari to the recent homicides. However, Cesare refuses to fulfill the killing be done because of Jane's beauty and he carries her out of her house instead, pursued by the townsfolk. Cesare releases Jane after a long chase, falls over from exhaustion, and dies.
In the meantime, Francis goes to Holstenwall's local insane asylum to ask if there has ever been a patient there by the name of Caligari, only to be shocked to discover that Caligari is the asylum's director. With the help of some of Caligari's oblivious colleagues at the asylum, Francis discovers through old records that the man known as "Dr. Caligari" is obsessed with the story of a mythical monk called Caligari, who, in 1703, visited towns in northern Italy and, in a similar manner, used a somnambulist under his control to kill people. Dr. Caligari, insanely driven to see if such a situation could actually occur, deemed himself "Caligari" and has since successfully carried out his string of proxy murders. Francis and the asylum's other doctors send the authorities to Caligari's office. Caligari reveals his lunacy only when he understands that his beloved slave, Cesare, has died; Caligari gets imprisoned in his own asylum then.
The narrative returns to the present moment, with Francis concluding his tale. A twist ending reveals that Francis' flashback, however, is actually his fantasy: he, Jane and Cesare are all in fact inmates of the insane asylum, and the man that he says is "Caligari" is his asylum doctor, who, after this revelation of the source of his patient's delusion, says that now he shall be able to cure Francis.
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