A framing device opens the film. A young man named Francis sits in a courtyard with another man, seemingly hypnotized by the sight of a catatonic woman named Jane walking past them. The sight of the woman under the influence of mesmerism stimulates Francis to relate to his companion a story that can only be described as strange and bizarre. Thus begins the narrative proper.
A fair has set up shop in a town in northern Germany. The highlight attraction of the fair is the peculiar Dr. Caligari and the even more spectacularly unusual Cesare. Cesare is a sleepwalker endowed with prophetic abilities when put into a trance by Caligari. There is a problem, however: Caligari must obtain a license from the local authorities before being allowed to perform. When he tries to get the license, the clerk with the power to authorize him is very scornful of the alleged “act” and laughs at him. The following morning that very clerk has been stabbed to death.
At this point, Francis and a friend named Alan show up at the fair and enter the tent where Caligari performs. They watch as Cesare, deep within a trance, emerges from the cabinet of Dr. Caligari to answer questions posed by audience members. Alan inquires how much longer he will live and is chilled by Cesare’s response: just until the next dawn. Sure enough, the next morning Alan has been stabbed to death. Francis connects the two unusually similar murders and suspects that Caligari and Cesare must be responsible.
Not only does Francis fail to find any evidence to support his suspicion, but another man is caught in the act of attempting to murder a woman. He claims to have nothing to do with the other two deaths, however. Francis still believes Caligari is somehow involved and returns to the fair at night to spy on the doctor. As he looks through the window into Caligari’s wagon, he sees that Cesare is there inside his box, apparently sleeping.
At the very same time that Francis sees Cesare sleeping in the cabinet, however, Cesare is also in another part of town, standing over Jane, Francis's beloved, holding a knife and on the verge of killing her. He does not follow through with inserting the blade into her skin because her skin is so perfect. She is simply too beautiful to kill. So he abducts her instead, but the commotion awakes her father, who chases after them along with some other townsfolk. After carrying her a fair distance, Cesare tires and drops the girl before himself succumbing to a state of exhaustion. Although Jane is sure that it was the sleepwalker who took her, Francis swears that it’s not possible, because he saw Cesare in Caligari’s cabinet at the exact moment she was abducted.
Francis and the police search Caligari’s wagon and the mystery is solved with precise simplicity: the Cesare that was in the cabinet is nothing more than realistic mannequin. Caligari makes his escape and finds sanctuary within an insane asylum. Francis follows and is brought to the office of the asylum's director, whom he is stunned to discover is none other than Dr. Caligari.
The asylum’s staff assist Francis by giving him access to the director’s personal records and diary while Caligari sleeps. Within this writing they discover that the asylum director is obsessed with a mystic from the 1700s named Caligari, who used a somnambulist named Cesare to become a serial killer in Italy. In an attempt to study the mind of the real Caligari, the asylum director has been conducting experiments into somnambulism with a man he turns into a modern day Cesare. Meanwhile, the police find Cesare’s dead body in a field neaby. When Caligari attacks a member of his staff, he is captured, restrained, placed into a straitjacket and turned into an official inmate within the asylum he once oversaw.
We return to the initial framing narrative, in which Francis is telling this story to his companion in the courtyard. The story ends and they return to the madhouse. Among the other patients is Cesare. When the director appears, Francis accuses him of being Caligari and pounces upon him. Francis is captured, restrained, placed into a straitjacket and then put in the very same cell which Caligari occupied in his story. The intertitles cryptically assert that Francis can be cured now that he understands the nature of his delusion. Horrifically enough, it was Francis who was insane all along.