A HighRankings Forum thread asks if there's an easy way to geotarget to a specific city and not to a general regional area (like Orange County, CA).
Indeed there is. There are many ways to target your ads, from countrywide (e.g. United States) to regional to citywide to a customized selection (for example, a 5 mile radius from Lexington, KY).
By default, American advertisers will often see something that looks like this, with United States selected as the default region:
However, as previously stated, you can change to a different type of targeting: countries/territories, regional, or customized:
It's likely that the advertiser at High Rankings was using this feature which targets specific metropolitan areas:
But if you want to drill down to city, you can do something like this:
Yes, Google AdWords is very customizable in this respect.
Forum discussion continues at High Rankings Forum.