This production of the ballet begins with a prologue, in which we see Herr Drosselmeyer (Alexander Minz), Clara's beloved godfather, who has apparently magical powers. He conjures up four Christmas presents, a Harlequin, a dancing doll who resembles Harlequin's traditional sweetheart Columbine, a Moor with a turban, and a Nutcracker. He is also busily making preparations for a puppet show that he will present to all the assembled guests at the party. The characters in the puppet show are a handsome Prince, a beautiful Princess, and a Mouse King.
Act I: It is Christmas Eve, and a Christmas party is about to be held in the home of Town Council President Stahlbaum (Gayle Young), his wife (Sallie Wilson), and their two children, Clara (Gelsey Kirkland) and Fritz (Warren Conover).
The party begins. Clara and Fritz receive presents from their parents, and then a mysterious figure in a hat and cloak appears. When the figure removes his hat, we see it is Drosselmeyer. Clara, overjoyed, rushes into his arms. As the boys march in their military uniforms that they have received as gifts, and wave their toy swords, Clara, Drosselmeyer, and some of the other children help finish decorating the Christmas tree.
The dances at the party begin, but the boys cannot resist being playful and bothering the girls. The commotion is halted by Drosselmeyer, who then presents his puppet show. It tells of a Prince who defeats and kills a Mouse King in a duel, winning the hand of a beautiful Princess. Clara, puzzled, watches the puppet show with enormous interest, perhaps noticing something familiar about the Princess (she resembles Clara). But the show in turn is interrupted by the boys, who cannot resist playing with their toy swords and disrupting things again.
With a wave of his bat-like cloak, Drosselmeyer produces three of the dolls seen earlier, who then become life-size. The Harlequin and the female doll dance together, after which the Moorish doll dances. But after these dances end, the dolls are carted away. Clara whispers something to Drosselmeyer, perhaps hinting that she wants a toy herself. Drosselmeyer has a mischievous look on his face, as if he had a special secret. He brings in a doll covered up by a handkerchief, places it on the floor, removes the handkerchief, and reveals a Nutcracker in the shape of a soldier, the same one we saw Drosselmeyer conjuring up at the beginning. Nobody is interested in it - except Clara, who is instantly enchanted with the toy and joyfully thanks Drosselmeyer. She dances happily with it, but, in ballet pantomime, she asks Drosselmeyer if he can make it grow to her size. He cannot, so he instead picks up the Nutcracker and helps Clara dance with it as if it were her partner. All this is observed by a drunken guest (Marcos Paredes), who tries to make the Nutcracker grow and accidentally pulls its head right off.
Drosselmeyer reprimands the guest and binds the Nutcracker as best he can for Clara. But it is time for the party to end. The adults dance the "Grossvater Vals" (Grandfather Waltz), the guests (including Clara's friends) bid Clara, Fritz and their parents goodbye, and then everybody leaves. Clara and Fritz are shuffled off to bed, and she, prompted by her nanny, regretfully leaves her Nutcracker under the Christmas tree.
After everyone is asleep, Clara sneaks downstairs to have a look at the Nutcracker, treats it as if caring for a child, and apparently falls asleep in front of it. Drosselmeyer's face magically appears on the living room clock as it strikes midnight. Suddenly, giant mice appear, circling and threatening Clara, who is apparently awakened by the commotion. Then more magical things happen. The Christmas tree grows to enormous size and the Nutcracker (Mikhail Baryshnikov), which has grown to the size of an adult, comes to life, protecting Clara. Toy soldiers march in, and a battle begins, led by the Mouse King (Marcos Paredes), also grown to giant size. (The Mouse King wears the same coat and cloak as the drunken guest at the party.) He and the Nutcracker engage in a ferocious duel with swords, and just when it seems that the Nutcracker is losing, Clara distracts the Mouse King by throwing a candlestick at him, enabling the Nutcracker to kill the Mouse King. But the Nutcracker also falls over as if dead.
Drosselmeyer appears to console the weeping, grief-stricken Clara. They prop up the Nutcracker, Drosselmeyer waves his hand over the face, and the Nutcracker becomes a handsome Prince (Baryshnikov again). He had had a spell placed upon him by the Mouse King, and only by killing him could he become a Prince again. The Prince approaches the shy Clara, and the two joyously dance together for the first time.
We then see what looks like a frozen lake. Snow begins to fall. Drosselmeyer magically converts the snowflakes into human form and they dance a waltz, during which we see Clara standing on a sled, a replica of the toy one that her parents have given her for Christmas. The Prince is pushing it along on the frozen lake. He and Clara then abandon the sled and run off to the Kingdom of Sweets.
Act II: Clara and the Prince arrive at the Kingdom of Sweets. Clara is now completely enamored of the young man who was once simply a Nutcracker. They meet the Prince's court, who all graciously welcome Clara and playfully toss her from one group to another. The Prince relates how Clara helped break the spell placed on him; then they all enter a great hall, where Clara is dressed in a beautiful gown and crowned Princess. She and the Prince then sit on twin thrones to watch members of the court dance for them. The other dancers perform the "Spanish Dance", the "Chinese Dance", the "Dance of the Clowns", the "Dance of the Reed Flutes", and the "Russian Dance". Then Clara and the Prince join everyone in the "Waltz of the Flowers", after which the Pas de Deux, which includes the "Dance of the Sugar Plum Fairy", begins. (The Sugar Plum Fairy's dances are performed by Clara in this version; in many productions including the 1892 original one, this section is performed by the Fairy and her Cavalier instead of by the Nutcracker Prince and Clara.)
Finally Clara and the Prince begin to dance the sad, beautiful Pas de Deux Adagio, and as they do, Drosselmeyer returns. It is almost time for Clara's dream to end, but she does not wish to return to the real world, and the Prince does not want to let her go. As she gently pushes Drosselmeyer away, she returns to the arms of the Prince. Drosselmeyer apparently leaves, frustrated at not being able to convince Clara to return to reality. The final waltz then begins, danced by the entire court. As Clara dances with the Prince, she notices something strange. The rest of the court is gradually moving away, and suddenly the Prince is nowhere in sight. As the rest of the Court disappears, Clara pleads with Drosselmeyer to bring them back, but he will not budge. Suddenly she is back in her own home. We are never actually told if she still has her toy Nutcracker with her, but presumably she does, and the last we see of Clara is her face peering out wonderingly through the window at the falling snow.