Continuity mistake: When the Witch flies off to Emerald City the monkey is standing by the window sill. The outside angle, where the window and rest of the set are a matte painting, has the Witch superimposed, but not the monkey.
Continuity mistake: Dorothy's house is outside of the tornado when we first see it up in the air. Then they are immediately inside the tornado. (00:17:15)
Continuity mistake: When the Wicked Witch tells Nikko "throw that basket in the river and drown him" his feet can be seen resting near her book of spells. In the next shot we see the book of spells back where it originally was to the right of the lamp. (01:16:40)
Continuity mistake: When the Wizard is in the balloon, he raises his top hat pointing in an 11 o'clock direction. A frame later it's pointing in a 9 o'clock direction.
Continuity mistake: Talking to the Wizard the Scarecrow says, "What about the heart you promised Tin Man " and the position of the characters changes between shots. (01:29:15)
Continuity mistake: At the start of the film when Dorothy comes running into the farm calling Aunt Em, Uncle Henry has just taken a chick out of a hat, and is placing it into an open coop. Yet when the shot changes his hand is instantly back in the hat taking out another chick. (00:02:15)
Continuity mistake: In the scene where Dorothy and the Scarecrow first meet and oil the Tin Man, the leaves on the Tin Man's shoulders appear and disappear several times. (00:40:50)
Continuity mistake: When Dorothy and the Scarecrow find the Tin Man and oil his mouth, between shots, the leaves on the Tin Man's shoulders change.
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.