Revealing mistake: In the Haunted Forest, when the Tin Man is lifted up then lands back on the ground, at Tin Man's lower back you can see his white T-shirt tucked into his pants. (01:14:10)
Continuity mistake: Inside the Emerald City, when they are at the palace entrance, the guard's mustache is turned up in the first shot, and is turned down in his next shot. (01:04:45)
Continuity mistake: When Toto escapes, he runs up to the three putting the Scarecrow back together and the Tin Man has nothing in his left hand. In the next shot the ax appears in his hand. (01:19:40)
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)
Continuity mistake: At first the Tin Man starts chopping the top part of the Witch's door with his ax and two shots later he's chopping about two feet lower, near the handle. If you look closely when he eventually gets the door open, the top part has not been touched. (01:23:40)
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.
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.