I figured this out. To anyone else who agonized over this for hours, here's the answer.
Add the statement \usepackage{graphix} in the Tex document in your project folder. This should appear in the preamble. That does the trick.
The code chunk for figure can be as simple as
```{r fig_2, out.width="2.5in", echo=FALSE, warning=FALSE}
plot(cars)