Micaëla approaches a group of soldiers detailed to observe activities on the marketplace, and asks after the whereabouts of Don José. On learning that he will not be there before the changing of the guard, she decides to go away and to come back later. With the new guard Don José appears and Sergeant Moralès tells him that Micaëla was there.
Don José and his superior Zuniga broach the subject of the tobacco factory and the gipsy girls who work there, now entering the square for their work break. Among the gipsies is Carmen, who captivates all men; piqued by Josés disinterest in her, she exercises all her charm on him. In a habañera she tells of her attitude to love, which in her view is a passing relationship which comes and goes as free as a wild bird.
The gipsies go back to work, and Don José, confused by Carmen’s song, is left alone. Micaëla comes back and brings him a letter from his sickly mother begging him to come back to his native village and to marry Micaëla. Together they recall having grown up together there.
Meanwhile a quarrel has broken out at the factory. Carmen has injured a worker with a knife. Zuniga interrogates her, but she makes fun of him and tries to flirt with him. with no success. She is on the contrary to be taken to prison by Don José. With a promise to dance for him at Lillas Pastia’s tavern she entices him into letting her go.
In Lillas Pastia’s tavern Carmen, Frasquita and Mercédès are dancing for the soldiers, among them Zuniga, from whom Carmen learns that Don José was punished with two months in prison and degradation. The famous torero Escamillo enters the tavern and his eye is immediately caught by Carmen, whom he sets out to impress by relating the dangers of bullfighting. Carmen is taken with the glamorous torero and promises a later rendezvous; with this prospect he leaves the tavern with his companions.
The smugglers Dancaïro und Remendado try to persuade the three women to take part in an escapade with them; Carmen turns them down and prefers to wait there for José. On the latter’s appearance she dances and sings especially for him. Don José declares his love for her with the wish that she will be his alone. The curfew signal is heard and José makes to return to barracks, on which Carmen jeers at his sense of duty and tries to persuade him to desert and start a new life with her in freedom. With a new declaration of love he repudiates this, but as he finally tears himself away he is confronted with Zuniga, who had previously made approaches to Carmen, with the result that the two men start a quarrel about her. The smugglers intervene and tie Zuniga up, so that Don José has not much choice but to shoot his superior and become one of the outlaws.
The smugglers Dancaïro and Remendado are debating how to get their contraband past the sentries and into town. Carmen has meanwhile lost interest in José, thereby earning his imprecations. Carmen, Mercédès and Frasquita are reading their future from Tarot cards. These indicate riches and happiness for the two girls, but Carmen herself draws the card of death. The smugglers explain their plan to the women. They are to flirt with the guards to divert their attention, and thereby enable them to slip into town with part of the contraband, leaving José to look after the remainder. Their going off without him kindles further jealousy in José. Meanwhile Micaëla is in search of him at the smugglers’ hideout, and Escamillo is also in the vicinity looking for Carmen. Meeting José, he brags of his amorous success with Carmen, which provokes José to quarrel and to challenge him to a duel. Carmen and the smugglers are able to prevent this at the last minute. As he leaves, Escamillo invites all present to his next bullfight. At this point Remendado discovers the concealed Micaëla, who tells Don José that his mother is dying. His decision to go home immediately reaps new mockery from Carmen, provoking the jealous José to speak darkly of seeing her again soon.
In front of the bullfight arena Carmen is awaiting Escamillo. The girls warn her that José, mad with jealousy, is back in town. The crowd streams into the arena. Alone outside, Carmen is joined by José. To his face she declares that she no longer returns his love, she now prefers Escamillo and her independence. José implores her to come back to him, but to no avail, and when she throws his ring at his feet, he kills her.