Mr. Dinkle (Bud Abbott) and Jack (Lou Costello) look for work at the Cosman Employment Agency, whose agent Polly (Dorothy Ford) catches the eye of Jack, whose simple advances towards her are interrupted by the arrival of her boyfriend (Buddy Baer), a towering figure of a police officer. Polly assigns Dinkle and Jack to babysit for Eloise Larkin's (Shaye Cogan) brother Donald (David Stollery) and their infant sister, while she and her fiance, Arthur (James Alexander), perform in a local theatre production. The babysitting duties are complicated by the fact that Donald is something of a prodigy, as well as a self-proclaimed "problem child". The dullwitted Jack is immediately outclassed by the child, and an attempt to lull the boy to sleep by reading the fairy tale Jack and the Beanstalk (Jack's "favorite novel") aloud fails when Jack stumbles over some of the larger words. Bemused by Jack's incompetence, Donald graciously agrees to read the story instead -- a role-reversal made complete when Jack falls asleep as Donald reads. In his slumber, he begins to dream that he is the young Jack of the classic tale.
Jack (Lou Costello) learns that the Giant (Buddy Baer), who lives in a castle in the sky, has stolen all of the land's wealth and food. The situation obliges the kingdom's princess (Shaye Cogan) to marry a prince (James Alexander) she never met, who is from a neighboring kingdom.
Jack must also make sacrifices, when his mother sends him to sell the last family possession, their beloved cow "Henry", to the local butcher, Mr. Dinklepuss (Bud Abbott). Along the way he meets the prince, who is kidnapped by the Giant soon after Jack resumes his merry way. The unscrupulous Dinklepuss trades five 'magic' beans to Jack for the cow. Upon returning home, Jack learns that the princess and Henry were kidnapped by the Giant.
Undeterred by his mother's disappointment over bringing home the beans, Jack plants them and a gigantic beanstalk grows overnight. He decides to climb the beanstalk to rescue everyone from the Giant's clutches, as well as retrieve "Nellie", the golden-egg laying hen that the Giant previously stole from Jack's family. Upon learning of Nellie's existence, Dinklepuss decides to join Jack on the adventure.
Upon reaching the top of the beanstalk, the two are captured by the Giant and imprisoned alongside the prince and princess. After the Giant assigns the hapless pair to toil around the castle, they befriend his housekeeper, Polly (Dorothy Ford), who helps them escape over the castle wall along with the royal prisoners, Nellie, and some gems that the Giant stole. (Nellie and the gems are then pilfered by the greedy Dinklepuss). They flee down the beanstalk with the Giant in pursuit, as Polly escapes the castle behind him, astride Henry. During the descent, Dinklepuss loses Nellie (who falls into the arms of Jack's mother) and then the gems, which rain down upon the impoverished townsfolk below. Once all are on the ground, Jack chops down the beanstalk, sending the Giant falling to his death.
Just before being rewarded by the King for heroism, Jack is rudely awakened from his dream by Donald, who breaks a vase over Jack's head just as Eloise and Arthur return from their evening jobs. Jack's angry outburst over Donald's behavior results in a second blow to the head from Dinkle, which returns Jack to his dream state. After greeting the others as their storybook counterparts, Jack walks off into the night with the bravado of "Jack the Giant-Killer".
Since Universal would not spend the money to make an Abbott and Costello film in color, the duo decided to do it themselves. Using the agreement with Universal that they could make one independent film per year, they made this film using Costello's company, Exclusive Productions and the second color film, Abbott and Costello Meet Captain Kidd using Abbott's company, Woodley Productions.