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https://www.youtube.com/watch?v=5LWfPnSFvwU
You can build as much as you want - and as much as your hardware can calculate. But yes, the game is indeed intended for smaller towns. Starting from 1000+ population, The AI gets a lot of issues. Even from 500+ population onward some people report glitched out citizens that cause supply issues.
You don't really NEED a large town in this game. At least not for the military part. A 300 pop town with all houses on level 3 will give you the best equipped militia you can get.
But if you want to build big, be prepared for some difficulties. The game needs to be tweaked significantly to allow for larger cities with less bugs and glitches arising.
At first, I had a bug that caused most of the level 3 houses to not be supplied with any food anymore. Found out that most food stall workers working the stands in the inner city were stuck in an idling stance and not doing their jobs, so I deleted all food stalls and along with them also all fuel stalls that were devoid of firewood/charcoal, as they seemed to have the same problem.
Disapproval disappeared after that, and now all my houses are 100% supplied again.
https://steamcommunity.com/sharedfiles/filedetails/?id=3250969724
So what I can say about larger populations: They might cause glitches, but there are workarounds to counter these glitches at the moment. The developer Greg is currently looking to hire more permanent team members that help with bug fixing and programming AI, so hopefully such issues will be resolved in future patches.
https://www.youtube.com/watch?v=by6Nz6QiCE4