Yes, it is possible to include / exclude any part of the code using compile time flags (and in the code using #if's) as you are trying to do.
In your case, I assume you have not defined __INCLUDE_LEVEL__
flag, hence the linker is not able to find funciton2, so the error.
If you define it, you will have three "main()" :-), it will fail again. So, you need to rework your code a bit.
Also, #include'ing a "C" file is not advisable and not used in practice. I assume you are just trying to experiment & learn, which is fine.