For understanding the movie, you need to know the basic ideas of Sigmund Freud's structural model of the psyche. The SUPER-EGO, the EGO, the ID. This is the general idea of Mulholland Drive. In the dream we see the duel, the fight, the cat and mouse game between the SUPER-EGO and the ID.

On the one side there is Diane's SUPER-EGO. It was build up by the high morally requirements of her parents, her small town life, etc.. It is Diane's conscience.
On the other side there is Diane's ID. It's her sexual drive, her libido. Her self-preservation instinct. Diane got a strong ID. And it is important that we know, that her parents are the main reason, why Dianes sexual drive was repressed for a long time.
The ID tries to suppress the truth. I don't kill somebody. Camilla is not dead. I'm a nice and innocent girl.

In the first part of the dream Dianes repressed sex drive is dominating the ID, but then it's her unleashed sex drive representing the ID. The SUPER-EGO tries to destroy the illusion. It wants that Diane faces the truth. I'am guilty! Camilla was real. Camilla is dead! I killed her! The super-ego is attacking the Id permanently. In the end we see what an immense impact this inner conflict has on Diane's ego. She is slowly getting mad, she has hallucinations and finally, the only way out is to commit suicide!

Notice:
The colour of the super-ego is blue.
The colour of the repressed (sex drive) ID is pink.
The colour of the unleashed ID is red.

The ID and the super-ego are acting very tricky and smart. Situations changes frome one second to another. Please remember Woody in this context. He brings it to the point: ACTING IS REACTING. Try to see the movie in this way. I'm sure you will discover things you 've never noticed before. Imagine how the super-ego is permanently sending soldiers to attack the ID.
I give you an example: The first scene with Adam Kesher. The super-ego is attacking (it wants to refresh Diane's memory of Camilla). The mafia-man opens up a suitcase (symbolizes that Diane locked up the memory of Camilla) and pulls out a photo of Camilla Rhodes.
The ID is reacting. It replaces the photo of Camilla with a photo of the partygirl (the one who was kissing Camilla).
Next try of the super-ego: THIS IS THE GIRL! The ID defenses: Adam is refusing. The ID is finally finishing this dangerous situation by serving the mafiaman a bad esspresso and the it itself is attacking the super-ego by attacking the car of the mafia men. The super-ego is loosing this battle. The ID is too strong. 

CUT/Betty is looking for Rita to be sure that everything is OK. The Illusion is not destroyed. CUT/ The super ego is planning the next attack: THEN WE ALL SHUT DOWN... Yes, MR. Rogue represents the super-ego!

...and the battle goes on...

Please watch the audition scene with Woody and imagine how the ID ist talking face to face to the super-ego. This is the moment when the super ego is gaining advantage ("slam dunk"). It's a trap. It' s the turning point. Pay attention to the colours: In the beginning, Betty is wearing a pink jacket over a blue top. Pink is fading. Red is coming up. In the end ( after the dream, when Diane is making coffee) a blue potholder lays over a red one!

This is my interpretation of the first dream.
DREAM-SYMBOL = MEANING
DANCING PEOPLE = TO HAVE SEX (ID)
HER OWN FACE = TO BE A FILMSTAR (ID)
HER PARENTS = MORALITIES: FILMSTAR IS GOOD/ DIRTY MIND IS BAD (SUPER-EGO)
PURPLE COLOUR = UPCOMING SEXUAL DESIRE (BETWEEN PINK AND RED)
MUSIC SOUNDS LIKE HORNS = CARS; CAR TRAFFIC

The dream ends. She is breathing in a sexual aroused way...the next dream can begin. - (kar)