In a brief prologue, the audience is introduced to a Swindler, who learns that he is at a palace, where a new Emperor is being crowned. Delighted, the Swindler intends to find easy marks there.

Meanwhile, everyone in the Palace bustles about with excitement, preparing for the coronation ("Emperor Marcus the Third"). We meet the royal advisers, a married couple named William and Deena, as well as the lowly royal scrub boy, Arno. The grand doors are opened to reveal the new ruler... but he's not there. In a panic, William rushes off to find him. We now meet Marcus, who is fourteen years old and insecure about ascending to the throne. He wants to cancel the event, but William bucks up the boy's confidence and gets him to the coronation. However, now that he is crowned, Marcus must help the villagers with their problems; unfortunately, he has no idea where to start.

In the royal portrait gallery, Arno and Emperor Marcus accidentally collide. It's the first time that the boys have ever met and they immediately like one another. Looking at the imposing line of ancestors in the portraits, Marcus confides that he's nothing like his fierce, wise, noble forebears. Arno suggests that maybe he needs more imposing clothes – if he looks like an emperor, maybe he'll feel like one, too ("The Ancestor Song").

Marcus commands Deena to dress him like an emperor, and she does her best, but the array of increasingly silly finery makes the young man look ridiculous. Villagers arrive with local problems for the Emperor to solve: a large hole in the road, an overflowing river. He is too insecure to make any decisions and resorts to more and more outlandish costumes for confidence ("The Emperor's New Clothes"). Outside of the Palace, the Swindler hears about Marcus' obsession with clothes and sees an opportunity for his next trick. The Swindler manages to convince Marcus that he is a tailor who can make magic clothes that are invisible to fools and liars ("Invisible"). Marcus becomes convinced that he will be able to see the truth in all situations and places an order for the clothes, commanding his advisors to give the new tailor anything that he wants. He also tells them to plan a parade, where his magnificent new clothes will be revealed. Deena is humiliated and upset; William is very concerned.

Following Marcus' orders, William sets the Swindler up in a fancy palace room that includes a golden chair. William is discomfited by how well the Swindler takes to being among the luxury of the palace, and Deena is embarrassed and upset that her clothes were not what Marcus wanted. Coming off of these insecurities, Deena and William become increasingly panicked that they will not be able to see the clothes, which would mark them as fools and liars ("I'm Not Scared").

Marcus and Arno meet up again in the garden, and Arno challenges Marcus to a guessing game. During the game, they discover that they each have a lot of special talents and abilities ("Only a Guy Like You"). Once the game is over, however, Marcus tells Arno that they can't see each other again since an Emperor has to keep up appearances. He adds that, if Arno comes to the parade, he will at least wave to him.

Meanwhile, the Swindler is making the most of being in the palace as he supposedly works on the magic clothes. He orders gold, pearls and all manner of exotic foods, keeping Deena and William dashing madly around to satisfy his whims ("We Wouldn't Want to Get Emperor Marcus Upset"). The problems in the village are getting worse, and Marcus hides to avoid having to deal with them. He is waiting until his magical clothes are ready before he attends to any business ("Make It through the Week"). He has several close encounters with townspeople but manages to avoid detection. When Arno happens by, Marcus grabs him and confides the situation. Arno inadvertently reveals him, and the chase is on again.

The night before the parade, everyone is preoccupied. William and Deena worry about whether or not they'll have a job tomorrow, once the new clothes are revealed. Arno can't wait for the parade, when Marcus will wave to him. Marcus anticipates his magic clothes, and the Swindler is already counting his money! ("How Am I Ever Gonna Get to Sleep"). In the morning, after he's been paid, the Swindler opens a clothes bag to reveal... an empty hanger. Marcus, Deena and William are each convinced that they are the only ones who can't see the clothes. Unwilling to admit it and afraid to be perceived as fools, they all begin to describe what they "see" as the Swindler confirms or corrects them. By the end, they are all enthusiastically praising the new clothes ("Invisible – Reprise"). The Emperor hurries off to get dressed in the invisible garments, for the parade is about to begin. The Swindler hurries to pack up his spoils and get out of town.

The parade is in progress, and Marcus is in his underwear. Arno stands on the sidelines, waving and cheering. As Marcus goes by, Arno blurts out the truth: Marcus isn't wearing clothes. No one will agree, however, even though it's the truth. Marcus doesn't know what to believe. He turns and asks the kids in the audience if he's wearing any clothes. They respond that he is not. Marcus is devastated, but Arno comes forward to remind him how special he is ("Only a Guy Like You – Reprise"). Deena and William agree, admitting that they were afraid to tell him the truth. Gaining confidence, Marcus makes his first official proclamation: everyone should be exactly who they are and should not worry about what other people think.

Suddenly, the Swindler is revealed, laughing hysterically at the Emperor in his underwear. He is arrested. As justice, Marcus makes him the Royal Scrub Boy and promotes Arno to Royal Truthsayer. He solves the problems of the realm by using his tons of clothes to plug up the hole in the road and dam up the river. As the parade resumes, everyone celebrates ("Emperor Marcus the Third – Reprise / Finale").