In the pleasant neighborhood bordering Sesame Street, Elmo (voice of KEVIN CLASH) is a friendly little three-year-old red "monster" who loves his comfy blanket, and will do anything to make people happy. When his friend Zoe (voice of FRAN BRILL), is upset that she didn't get to go the zoo, Elmo cheers her up.
Yet when she wants to hold his blanket, Elmo gets upset. As the two get in a tug of war over it, they don't see Telly (voice of MARTIN P. ROBINSON) who accidentally skates into it, sending Elmo on a wild chase trying to retrieve it. The blanket, however, gets away from him and lands near Oscar the Grouch (voice of CAROLL SPINNEY) who uses it to blow his nose and then throws it into his trash can.
Elmo learns of this and, impatient for Oscar to return, jumps into the can and ends up in Oscar's home. While retrieving the blanket from a lever on a wall, however, Elmo and his blanket get sucked through a colorful tunnel into Oscar's hometown of Grouchland.
There, he meets various characters, including Grizzy (voice of STEPHANIE D' ABRUZZO), as well as the greedy Huxley (MANDY PATINKIN) who, along with his assistant, Bug the bug (voice of JOSEPH MAZZARINO), steals Elmo's blanket and claims it as his. Elmo obviously wants to get it back and with some help from Grizzy, sets out for Huxley's castle to retrieve it.
Meanwhile, Elmo's friends on Sesame Street are concerned about their friend, and so set out to help him. When they arrive in Grouchland, however, Big Bird (voice of CAROLL SPINNEY), the Cookie Monster (voice of FRANK OZ), Oscar and several of their human friends are arrested and put in prison.
With his friends unable to help him, Elmo continues his quest to get his blanket back, a journey that leads him through various adventures, including a trip to Da Dump, ruled by the Queen of Trash (VANESSA WILLIAMS), while contending with Huxley and his minions, the Pesties, who try to stop his quest.