The drawing room is filled with warmth and merriment as the Stahlbaum family welcomes relatives and friends to their annual Christmas festivities. Clara comes downstairs to join the party only to be confronted by a vision of giant mice. Frightened, she brushes away the memories of her dream and runs into her mother's arms. She is drawn into the happy celebration and the party continues until Herr Drosselmeier suddenly appears.
Godfather Drosselmeier is a mysterious figure, well-known to all children of Nuremburg. Despite his odd manner and appearance, he is a great favorite in the Stahlbaum home since he always brings surprises. This time, however, Clara is a little afraid of her Godfather because of his strange role in her dream. Annoyed by Clara's shyness, Herr Drosselmeier gives Fritz a Mouse King doll and encourages him to tease Clara and disrupt the party. Then, to entertain all the guests, he presents two life-sized dancing dolls, a beautiful young ballerina and an Eastern sword dancer. Clara is fascinated by the ballerina doll and tries to persuade her godfather to give it to her. He refuses and instead produces three figures who re-enact Clara's nightmare in a masque. Now Clara is truly frightened and would run away if her amazing godfather did not conjure up another surprise: a wooden Nutcracker. Clara is enchanted with the present and dances happily until her mischievous little brother, Fritz, grabs the doll and breaks it. The children's godfather steps in once more to bandage the wounded Nutcracker with his handkerchief and to dry Clara's tears.
As evening draws to a close, Dr. Stahlbaum invites everyone, even the smallest children, to join in one last dance. Slowly the guests depart and Clara and Fritz are led off to bed.
After the Stahlbaum family goes to bed each night the resident mice make themselves at home in the drawing room. On Christmas Eve the first to appear are two baby mice, followed by their mother. Clara enters, looking for her Nutcracker, and accidentally trips over one of the baby mice. Mother Mouse runs off in a panic to call the other mice.
Clara is transformed into the beautiful young woman of her fantasies and, where the Nutcracker fell, a handsome Prince appears. Together they walk from the Stahlbaum drawing room out into the Land of Snow. There Clara and her Prince dance together, joined by swirling flurries of snowflakes.
Clara and the Prince are aboard a golden boat sailing through visions of a magical land. They dock at an exotic port where they are greeted by the kingdom's Grand Pasha and his entourage. Clara notices that the Pasha looks suspiciously like her Godfather Drosselmeier. The Prince tells the story of the battle between the Nutcracker and his soldiers and the army of mice. Clara is praised for her bravery in saving the Nutcracker.
The Pasha, as Master of Ceremonies, brings on one group of dancers after another to entertain his honored guests. They see Moorish couples, a brilliant peacock in a gold cage, a Chinese tiger and his attendants, whirling dervishes, three commedia dell'arte characters, a special surprise prepared for Clara by the Pasha, and a waltz danced by girls dressed in the colors of spring flowers.
For their new friends, Clara and the Prince dance a romantic pas de deux, expressing their young love. All the Pasha's entertainers join them in a grande finale. At the height of the festivities the golden boat returns. It is time for Clara and the Prince to continue on their journey. Clara is reluctant to leave and, as she hesitates, the Pasha sends the boat on without her.
The magic kingdom fades and our story ends, as it began, with Clara on her bed in her own room, wondering where fantasy ends and growing up begins.