Revealing mistake: As Dorothy is about to walk into the cyclarama (backdrop) as she leaves MunchkinLand, a Munchkin Soldier on the very far right is too far and becomes transparent with the matted-in flowers. (00:33:40)
Revealing mistake: When they meet the Wizard for the first time, his big projected head doesn't reflect off the shiny floor, like everything else. (01:09:54)
Revealing mistake: When the doorman initially refuses to let Dorothy and friends into the Emerald City, they protest, saying the Good Witch of the North sent her; they show him the ruby slippers as proof. As the camera pans down to the slippers, look at the yellow brick road Dorothy is standing on - it is flat and looks as though it was simply painted.
Revealing mistake: When the Wicked Witch throws the ball of fire at the Scarecrow, you see the Tin Man get down on his knees and take off his hat to put out the fire. If you look really closely, you can see several hairs on the Tin Man's head.
Continuity mistake: When Professor Marvel guesses why Dorothy is running away, she's holding her suitcase with the lid facing Marvel. But in Toto's closeup, as he snatches the hotdog from Marvel's long grill fork, the suitcase is turned the opposite way with its lid facing Dorothy. Then it changes back, so the suitcase lid faces Marvel again. (00:12:10)
Continuity mistake: After Zeke rescues Dorothy from the crowded pig pen, Hickory wipes his face and neck with the rag in his right hand, but then it cuts to another angle, and the rag is suddenly in his left hand. (00:04:20)
Continuity mistake: When Dorothy slaps Lion on the nose for chasing Toto and shouts, "Shame on you!" in the wide shot, we see Dorothy's right arm with no mark on her skin. It then cuts to the medium shots, and there's an inexplicable long, thin blue mark (it's not a loose thread) on Dorothy's arm near her elbow, while she's holding Toto. This blue mark vanishes in the wide shot when she puts Toto down, and Lion begins to sing. (00:50:25)
Continuity mistake: While Dorothy, Tin Man, and Scarecrow are walking in the dark and creepy forest, just as Dorothy begins to sing "Lions and Tigers and Bears" in the medium shot, Tin Man is holding up the axe in his left hand. But it cuts to the long shot, and the axe is in Tin Man's right hand between shots. (00:48:40)
Answer: In the film it's left ambiguous. At the end it's strongly implied that she was dreaming. The characters she meets all look like people she actually knows. In the original book, she actually went to Oz.