Encryption algorithm that produces dummy output on incorrect passwords
Yes, this is possible (conditionally). It sounds like you want Format Preserving Encryption. FPE works by encrypting from an arbitrary domain $X$ onto $X$. Consequentially, if plaintext $M \in X$ is encrypted to ciphertext $C \in X$, any decryption of $C$ - even with the wrong key - will yield a decrypted message inside of $X$. Thus an attacker doesn't know anything from a decrypted ciphertext if he only knows the original format of the valid plaintexts. All decrypted ciphertexts look like valid plaintexts to him.

For example, your domain might be "all ASCII strings of length 7", or "a NULL-terminated string of numbers with length less than 10", or some credit-card number format. All plaintexts, ciphertexts, and wrong-key decrypted ciphertexts will be in that domain. From your example, you might have a domain of 9 ASCII numeral digits.

(In case it's not obvious: The way an attack typically works is that the attackers are decrypting a ciphertext onto a plaintext message space $Y$, but they know something about the original plaintext that limits the potential domain to some set $Z$ strictly contained within $Y$ (that is, $Z \subset Y$). On a typical cipher we encrypt $\{0,1\}^n \rightarrow \{0,1\}^m$ (one binary string to another), but it's rare that all plaintexts could actually be any binary value, generally they are only a strict subset of the input domain. So we assume the attacker knows which plaintext formats are valid, and they just check decrypted plaintexts against this smaller domain. FPE addresses that issue by only allowing encryption and decryption from and to domains that are valid plaintexts. The attacker will never be able to look at a decrypted value and conclude that it is an invalid plaintext. Eg, if they are decrypting a credit-card number, they have an idea of what a valid decrypted CC will look like, but with an FPE algorithm all decrypted messages will look like a valid CC.)

Note that this won't mitigate the problem if the attacker knows some part of the original plaintext that does not apply to all valid plaintexts. FPE mitigates attacks where the attacker just knows the original message space for all valid messges, but it's possible they know something about the specific message on hand that doesn't apply to other messages. (For example, they may know that the 3rd digit is an 8 for the plaintext in question, but not necessarily an 8 for all plaintexts.) In this case they would have a smaller domain to check decrypted messages against and their original attack will still help them to some extent.

An FPE algorithm can be implemented from an existing block cipher. There are different schemes for turning a block cipher into an FPE, depending on your domain size and such. Some of the constructions are relatively simple given the block cipher and a function that decides whether a raw block cipher output is inside of the desired domain. The Wikipedia page linked to above contains descriptions of some.

As for your example: I think that it's rare to see FPE applied to very large domains, like image files. It's usually only applied to small domains, things like credit-card numbers in databases. I don't think I've seen it used in a case where the domain was larger than a couple block cipher blocks. (But whether you can use FPE efficiently on very large domains is a different question.)