Ahmad, a blind man begging on the street with his dog, is brought unknowingly to the palace of the Grand Vizier of Bagdad, Jaffar. Prompted by the ladies of the palace, he tells his story. Once the king of Bagdad, Ahmad ruled from a distance, with Jaffar at his side. Wanting to learn more about his people, he takes up Jaffar's suggestion that he travel out into Bagdad in disguise, so that he might observe them unknown. But Jaffar tricks Ahmad, and has him arrested and thrown into jail as a madman.
In his cell, Ahmad meets Abu, a lowly thief boy. The two are told they are to be executed at sunrise, but thanks to Abu's ingenuity, they escape. With Jaffar's troops in pursuit, they make their way to Basra. There Ahmad by chance sees the Princess, whose father has decreed that no man is permitted to look upon her. Against the advice of Abu, who wants adventure, he insists on seeing her again, and the two agree to meet later that night.
Ahmad visits the princess's garden, where he conceals himself in a tree. Tthe ladies-in-waiting see his reflection in the water and believe him to be a djinni. In this way he introduces himself to the princess, who is enthralled. Revealing himself to the Princess, he declares his love for her and they agree to meet again. Reluctantly, Abu agrees to help him evade the guards.
The next day, the Sultan of Basra is visited by Jaffar, who brings him as a gift an addition to his outstanding collection of toys: a mechanical flying horse. In return, he asks the Sultan for his daughter's hand in marriage. To the horror of the Princess, the Sultan agrees. The Princess flees, but Ahmad and Abu are captured by guards and brought before the Sultan. As Ahmad and Abu is about to reveal Jaffar's treachery, Jaffar casts a spell upon them, turning Ahmad blind and Abu into a dog. The curse will remain in place until Jaffar holds the Princess in his arms.
When Ahmad concludes his story, telling the ladies that he has wandered ever since in search of the Princess, he is told that the Princess is in the palace, in a deep sleep from which no doctor can wake her. They take Ahmad to her, and in his presence she revives, while Jaffar watches unobserved. Hamila, Jaffar's servant, hurries Ahmad away, telling him the master is returning. Ahmad leaves his dog, Abu, to guard the Princess. When Ahmad has gone, Halima tells the Princess that there is a doctor who can restore Ahmad's sight, and agrees to take her to him. But when the Princess is led to a ship at port, she finds only Jaffar. Setting sail, Jaffar has Abu thrown overboard, and tells the Princess that Ahmad's curse will only be lifted when he holds her in his arms. Desparate to cure Ahmad, the Princess relents, but although the spell is broken, he and Abu are stranded on land. They set off in pursuit, but Jaffar sends a wind against their small boat, and they are shipwrecked.
At the Princess's request, Jaffar heads back to Basra, where the Princess begs her father not to let her marry Jaffar. The Sultan agrees to help her, but Jaffar overhears, and presents the Sultan with a new toy, a multi-armed dancing girl, the Silver Maid. The Sultan is delighted, but when he dances with the mannequin, it produces a knife and kills him. Satisfied, Jaffar orders the guards to prepare for a return to Bagdad.
Abu finds himself washed up on a deserted beach, where he happens upon a bottle which, when he removes the lid, releases a djinni. The djinni grows to a colossal size and threatens Abu, but he manages to trick him back into the bottle. In return for releasing him, the djinni promises him three wishes. For his first wish, Abu requests a meal of sausages. The djinni obliges. Abu then asks where Ahmad is, but the djinni tells him that he will first need the All-Seeing Eye. He agrees to take Abu to the Highest Mountain in the World, where he will have to steal the Eye himself from the Statue of the Goddess. Climbing the statue, Abu fights off an enormous spider and retrieves the Eye. In the Eye, Abu sees Ahmad lost and alone in the mountains. Abu uses his second wish to go to him.
Reunited, Ahmad expresses to Abu his longing to see the Princess again. Abu shows him the Eye, and Ahmad sees the Princess with Jaffar, about to inhale the Blue Rose of Forgetfulness, which will destroy her memory for ever. Ahmad and Abu quarrel, and Abu wishes Ahmad off to join the Princess. His last wish spent, the djinni abandons him, and Abu finds himself lost and alone.
Ahmad arrives in Bagdad just in time to break Jaffar's spell on the Princess, but he is overpowered and he and the two lovers are imprisoned, to be executed at dawn. Abu watches powerless in the Eye, and in his fury, he smashes the Eye, and is instantly transported to a mysterious land of legend, where he is welcomed as a prince, releasing the land from its curse of petrification. The old king presents Abu with a magic bow and arrows, and offers him everything in the kingdom, excepting only a flying carpet, which he means to take him to paradise when the time comes. But Abu is unable to resist and steals the carpet to take him to Bagdad.
Abu arrives just in time to save Ahmad from the executioners' axe. As the people, believing Abu to be answer to a prophecy, storm the palace, Jaffar makes his escape on the flying horse, but is brought down by Abu with a magic arrow. Ahmad makes his speech to the crowd, offering to make Abu his new Grand Vizier, but Abu has other ideas, and sets off on the carpet in search of adventure.
