Theories
Shared hallucination
As per Dave's assertion in this episode, the "survivors" are all patients of the Santa Rosa Mental Institute, and the Island is just a shared hallucination.
All the crash survivors are imagining the Island, perhaps caused by the medication or are in some form of suspended animation
This is a type of group therapy. This explains why people "die" soon after having a breakthrough.
The Dharma Initiative is the project name for the group therapy funded by the Hanso Foundation.
Most/all of the characters seem to show some hint at mental instability. Any of the following are reasons for depression or other mental illness:
Locke had a kidney stolen by his father and has difficulty dealing with the loss of his legs. If the island were imagined, this would explain his magical walking.
Kate killed her "step" father, Wayne. She also caused the death of ex-boyfriend Tom while resisting arrest.
Jack lost his wife and testified against his father.
Sawyer watched his parents die in a murder/suicide after they were swindled out of their life savings.
Michael was in a brutal car accident resulting in long hospital recovery. His ex-girlfriend Susan used the accident to gain full custody of their son Walt.
Walts mother died.
Jin has a pretty stressful job as a henchman for Suns father.
Sun felt her marriage was failing and is afraid of Jin. Her fear was strong enough that she secretly learned English to escape to America.
Ana-Lucia was shot and injured by a suspect. Later, she tracked him down and killed him.
Eko became a notorious criminal and watched his brother die because of his scheme to export drugs out of Africa.
Shannon was cheated out of her inheritance and seduced her brother, Boone. She was killed in the show, which may indicate that her relationship with Sayid helped cure her of the selfishness and relationship anxiety she had been experiencing.
Boone was killed shortly after coming to terms with letting go of Shannon. He appeared to stop caring for her and his emotional freedom from Shannon may have been the trigger to end the therapy.
Sayid was forced to become a torturer and later killed his superior while helping his lost love, Nadia, escape. In Sydney, he was told that Nadia was residing in Irvine, CA. But in a scene with Rousseau, he states that Nadia is dead.
Hurley and Libby are both former mental patients at S.R.M.I.
The various manifestations that the "survivors" see (Jack's father, Kate's horse, Desmond, The Numbers, etc.) are related to the shared hallucination.
The buildings on the Island that resemble hospital facilities, like The Staff and The Arrow, are the stand-ins for their real-life counterparts in the hospital.
The Others are actually the nurses, staff, etc. of Santa Rosa Mental Institute. The backwards whispering would be the doctors observing and talking. Similarly, Walt talking backwards could indicate that he is cured or no longer part of the shared hallucination.
The Hatch says "QUARANTINE" to keep the crazy people in their proper environment.
The Mural also implicates an advanced mental institution, the "Arts and crafts."
While the creators have said that the Island is not the product of one persons imagination. They have NOT said that it is not a shared hallucination among multiple people
In spite of the creators claims, what Dave says might be true. Libby's experiences might be all made up by Hurley's mind
