Alt Gr key no longer a level 3 shift ater upgrating to 21.10

I recently upgraded to 21.10. During upgrade the system asked me which key I wanted to use for latin character input. I answered Alt Gr. However I’m an Icelandic keyboard user and use that key for a third level shift. E.g. to type @ I used to be able to type Alt Gr + Q. Now I’m not longer able to, it just types q. In fact pressing Alt Gr seems to switch over to the English keyboard. I don’t want this behavior as Super + Space already does this.

I tried going to the Keyboard settings and under “Alternate Character Key” set it to “None”. This disables the temporary english keyboard but typing Alt Gr now has no effect at all. In fact it functions as a simple Alt.

If I go looks at the keyboard layout, it says that the key is a level 3 shift, however I can’t figure out how to set it back to being an actual level 3 shift like it was before I upgraded to 21.10 (in the meantime I’ve remapped my Caps Lock to level 3 shift).

Here is the output of cat /etc/default/keyboard:

$ cat /etc/default/keyboard 
XKBLAYOUT="is,us"
XKBVARIANT="runarberg,"
BACKSPACE="guess"
XKBMODEL="pc105"
XKBOPTIONS="grp:toggle,grp_led:scroll"

In addition to the steps described in vanadium's answer, I would suggest that you open the /etc/default/keyboard file for editing and replace this line:

XKBOPTIONS="grp:toggle,grp_led:scroll"

with

XKBOPTIONS="grp_led:scroll"

That should prevent you from the risk that the problem re-appears.