Film's Cave Theory is loosely based on Plato's famous "Allegory of the Cave." The idea being that the audience members watching a film are equal to Plato's prisoners chained in the cave. The filmmakers (Plato's puppeteers) offer them an artificial reality in the form of light and shadow projected onto a screen (or wall). The audience becomes convinced of the reality of the images to the point where they either fear or cannot recognize the real, natural world. In this theory, film as an art (or artificial construction) is contrasted with reality in an attempt to understand the relationship a film has with (or the effect a film has on) its audience.
An analysis of a film using Cave Theory, then, involves looking carefully at the idealized or artificial diegetic world the film presents, comparing it to reality (the non-diegetic world), and examining the motives or purposes behind the film's adjustments. What does the film expect it's audience to believe and why? How effective is the film in convincing the audience of its reality? What are the possible consequences or outcomes of audiences believing the diegetic world of the film?