She didn't kill her sister. She tried to shoot the step dad and missed, hitting the light bulb. He had killed the sister first and blamed her. This is proven at the end when the creepy orderly screams about all he knows about the step dad. The fantasy world is babydoll's imagination. The one with dragons and swords is imaginary, but is somewhat real in that it helps her get what she needs to escape. The dancing world is also a fantasy to make life in the institution not seem so bad. She was only there for about a week and made these images to help her survive (i'm sure the russian woman helped with that). At the end she is lobotomized and it all becomes clear. She did stab the guy and did help the girl escape, she had just glamorized it in her mind. I Hope this helps.