Plot device used in many movies, but most effectively in horror movies
, where a portion of the movie is set in a theater and the action on the screen parallels or cointerpoints the action in the main movie.
Some examples include Scream 2
(one of the creepiest films ever
IMO), and Demons
When it is done right, such as in Anguish, the audience doesn't realize what movie they are watching at first -- the film, or the film within the film.
From Baffo comes Hamlet, the classic play-within-a-play, and The Spanish Tragedy by Kyd, which I am not familiar with. Thanks Baffo!
TrojanJedi points out that Scream uses the device with Halloween. This is especially interesting, for Halloween features an intercutting with Howard Hawks's version of The Thing. A twofer!
favorite examples? I will assimilate your /msgs with due credit if you like.