Sancho watches his dreams of earldom get destroyed. Dorothea can’t believe her new found happiness is real. Cardenio and Luscinda are also in a state of disbelief at the turn of events. Don Fernando gives thanks for being saved from himself, which would have resulted in both the loss of his soul and honor. Cardenio and the curate promise to pay the damages incurred by Don Quixote, and the landlady is satisfied.
When Don Quixote wakes, Sancho tells him he might as well go back to bed. Everything is resolved. Don Quixote remembers the battle he had where he beheaded the giant. Sancho tells him he merely slaughtered wine skins, and Dorothea is not a princess after all. Don Quixote blames the changes on the enchanted castle they are in. He wishes to see the transformations himself.
The curate meanwhile tells Don Fernando’s group about Don Quixote’s madness and how they lured him there. Dorothea’s good fortune interferes with their plans on using her further. They need to come up with a another story. Cardenio suggests that Luscinda take up the role. Fernando says he would like to help Quixote and suggests that Dorothea continue the role.
Don Quixote tells Dorothea that he has been told that she is not a princess, but merely a damsel. He believes that her father disinherited her because he believed that Quixote couldn’t perform the deed. Other less famous knights, Quixote points out, have managed to accomplish more difficult tasks. He has killed her giant. He promises to get Dorothea’s crown restored to her head.
Dorothea tells him he has been misinformed. She is the same person as she was yesterday. She has changed in that she has been given back what she loves, but she still needs his assistance.
Don Quixote is angry with Sancho for telling lies. Sancho says he may have been mistaken about the princess, but the landlord can still vouch that Quixote merely cut open wineskins and not a giant. Don Quixote dismisses it.
Don Fernando tells him that the princess will leave tomorrow. Their conversations is brought to a halt by the arrival of man and a woman dressed in Moorish fashion. The man is upset to learn there are no rooms at the inn. Dorothea offers to have them share their apartments. The man tells them the woman doesn't speak their language, but he thanks them for their offer.
The man tells them that the woman is a Moor, but she desires to become a Christian. Luscinda has asked if she has been baptized, but the man replies there has been no time for that. Her life wasn't in danger, and so they are waiting for her to learn the religion first.
Everyone is entranced by the woman's beauty when she removes her veil. Sancho asks her name, and the man says it is Lela Zoraida. However, the woman insists she is to be called Maria.
They all sit down to supper. Don Quixote makes a long speech about the profession of arms and how it brings peace. He speaks rationally, making it hard to believe that he is mad. He continues to discuss how a soldier’s life is meaner than a poor peasant’s. He believes that this is why knights have fallen out of fashion.
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