This phrase is used to criticize things. When you don't think something is good enough or realistic enough, you say "Is that supposed to be ___?" For example, if someone compliments your hair cut, but says it in a way that actually sounds rude, you can respond:

Is that supposed to be a compliment or something?

Or when someone tries to make a joke, but the joke offends you:

Is that supposed to be funny?

You can use "this" with the phrase as well as "that":

What, is this supposed to be a nice restaurant? If you ask me, it's way overpriced and not all that good.