Twin Peaks centers on the investigation into the murder of schoolgirl Laura Palmer (Sheryl Lee), in the small rural town in Washington state after which the series is named.

In this episode, Federal Bureau of Investigation agent Dale Cooper (MacLachlan) tells Sheriff Truman (Ontkean) and his deputies about a unique method of narrowing down the suspects in Palmer's death.

[3][4] The Horne family—Ben (Richard Beymer), Audrey (Sherilyn Fenn), and Johnny (Robert Bauer)—are eating dinner when they are interrupted by Ben's brother Jerry (David Patrick Kelly).

They decide to visit One Eyed Jacks, a casino and brothel across the Canada–US border, where Ben wins a coin flip to determine who will be the first to sleep with the newest prostitute.

Bobby Briggs and Mike Nelson (Gary Hershberger) drive into the woods to pick up a hidden delivery of cocaine, but are ambushed by Leo Johnson, who demands the $10,000 the pair owe him.

The next morning, Cooper gathers together Sheriff Truman (Michael Ontkean), Deputies Hawk and Brennan (Harry Goaz), and Lucy Moran (Kimmy Robertson) in a forest clearing to demonstrate his unusual approach to eliminating suspects from their investigation.

Cooper retires to bed at his hotel room, and experiences a strange dream featuring the one-armed man, who identifies himself as MIKE, and BOB, who vows to "kill again".

The Red Room seen in the episode's final scene was created from scratch by Lynch for the European release of "Pilot", and was not originally intended to be a part of the American series.

[10] The director first met Anderson in 1987 while continuing work on Ronnie Rocket, a planned film project about "electricity and a three-foot guy with red hair" which was ultimately scrapped.

[20] Kimmy Robertson—who plays sheriff's office receptionist Lucy Moran—has described Lynch's directorial style as hypnotic, finding that his question-and-answer approach of discussing scenes with the cast was unique among directors she had worked with.

[23] The fact that the series' protagonist embraces this intuitive manner of deduction sets Twin Peaks "at odds with the naturalistic trend in analytic philosophy".

[22] This dreamlike approach is a hallmark of Lynch, who, according to Greg Olson in his book Beautiful Dark, "has always identified himself as an artist first, a man fascinated by spiritual realms who's committed to expressing his inner life".

Writing for The Boston Globe, Gail Caldwell compared Lynch and Frost's script for the episode to the works of mid-20th century American writers Sherwood Anderson, Flannery O'Connor and Truman Capote, describing it as an "excavation of the fear and madness poised behind an ordinary small-town veneer".

He praised the episode's portrayal of the Black Lodge, called the dream sequence "some of the most disquieting filmmaking Lynch has ever done", and described its depiction as "a weirdly All-American supernatural system" that seems "completely terrifying".

Club writer Noel Murray felt that the episode pushed "into previously unexplored television territory", and that the climactic Black Lodge dream sequence came to be seen as "the signature moment in the entirety of Twin Peaks".

[35] Writing for AllMovie, Andrea LeVasseur rated the episode four out of five stars, called it "memorable and pivotal", and described the Red Room dream as "unforgettable".

Chaney described it, and the dream sequence specifically, as having "turned Twin Peaks into a water-cooler phenomenon", and noted that it may have inspired later series such as The Sopranos and Lost to "feel comfortable taking risks with their audience".

[37] The Washington Post's Tom Shales has described the dream sequence as "the scene that separated the men from the boys", noting that it further polarized the series' audience, attracting loyal viewers and putting off others.

[39] Siegel added that "anyone with less than a semester's worth of either Postminimalism 101 or Absurdism 102 can come up with dancing dwarves, one-armed men, psychic detectives, psycho killers, llamas in the waiting room and hints of incest and necrophilia", and felt that a reliance on surrealism made Lynch seem to be a "one trick pony".