Step 1: Relate the differential equation to a geometric property.
The family of all circles of a fixed radius 'a' has a constant radius of curvature equal to 'a'.
The formula for the radius of curvature, $\rho$, for a curve given by $y=f(x)$ is:
\[
\rho = \frac{[1 + (y')^2]^{3/2}}{|y''|}.
\]
where $y' = \frac{dy}{dx}$ and $y'' = \frac{d^2y}{dx^2}$.
Step 2: Apply the condition for the family of circles.
For any circle in the family, the radius of curvature is constant and equal to its radius, 'a'.
So, we set $\rho = a$.
\[
a = \frac{[1 + (y')^2]^{3/2}}{|y''|}.
\]
Step 3: Rearrange the equation to match the options.
Move $|y''|$ to the other side:
\[
a |y''| = [1 + (y')^2]^{3/2}.
\]
Square both sides to eliminate the square root and the absolute value:
\[
a^2 (y'')^2 = ([1 + (y')^2]^{3/2})^2.
\]
\[
a^2 (y'')^2 = [1 + (y')^2]^3.
\]
Step 4: Rewrite the equation using the notation $y_1$ and $y_2$.
Using the standard notation $y_1 = y'$ and $y_2 = y''$, the differential equation is:
\[
a^2 y_2^2 = (1+y_1^2)^3.
\]
This matches option (B).