Revealing mistake: In the forest scene when they walk up to the warning sign, watch and you'll see the Scarecrow's stick bend like rubber.
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.