The ending spoofs "The Wizard of Oz" with its unpredictable twist in black and white. It's quite unlikely that anybody would have such a detailed and long "dream". The same twist was used with comparable comic effect in the "A Fistful of Yens" segment from "The Kentucky Fried Movie".
Then, you have a second plot twist with a variation on the opening scene in the drive in and Florence being on the loose, with a cliffhanger similar to those in cheap horror movies from the era. It could be another dream for Florence or she really escaped from the institution.
Actually, neither of these two twists lead the audience to reconsider the entire movie, as it happens for instance in "Mulholland Dr.". The point is that the entire movie is a fantasy and in the end it matters little whether it's Florence, Larry Elkins or anybody else who was the killer. The "Beach Party" or "Giglet" movies were also fantasies (and completely innocent, compared to "Psycho Beach Party") with unbelievable plot elements and the twists remind us that we shouldn't expect too much from unrealistic characters.
The final twists were added for the movie version compared to the original play, in which Chiclet was played by Charles Busch in drag (he was the police officer in the movie), which made the parodic tone more obvious. And the twists wouldn't have worked on stage.
By the way, if you enjoyed this movie, try "Lord Loves A Duck" from 1963. It's arguably a better deconstruction of the whole "Beach Party" movies.
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