Henry Cobb wrote:

If it was all in his head, then he was going around and saying some VERY
strange things all that time.

What's the reaction of everybody else to this, from the start?

While the story leaves this ultimately up to the readers' imaginations,
my answer would be that the process took place in stages:


Stage 1: Ataru starts daydreaming frequently about a bikini-clad alien
princess and her weird friends.

Reaction: "Hey, don't you think Ataru's acting a little weird lately?"
"Compared to what?" "Whattaya mean, 'lately'?"


Stage 2: Ataru starts confusing daydream life with real life; talks
about Lum and friends as if they were real.

Reaction: Send him to doctor (Cherry, who is a doctor rather than a monk
in this alternate existence).


Stage 3: Ataru believes daydream is real, only interacts with real
people in a limited way.

Reaction: Try to talk him back to real life (as Shinobu did in the
story).


Stage 4: Ataru totally immersed in dreamworld, loses contact with
reality.

Reaction: As seen in story.


In another post, Travis Butler wrote:

Um, Henry, it's really simple: The whole UY series is all in Ataru's head 
-- none of it is real. It's all a dream created by an alien race to suck 
Ataru's life energy... as was OMG for Keiichi (for which I shall kill you 
later, Gary)

BWAHAHA!! Come and get me if you dare... :-P

Gary Kleppe
kleppe@execpc.com, Home page http://www.execpc.com/~kleppe
My fanfics and the FFML map are on my comics/manga page,
       http://www.execpc.com/~kleppe/comics