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I tend to build cities in tiles that give me access to luxury resources within the 5x5 fat cross and I try to build them on coasts whenever possible. However, the AI sometimes suggests very odd city placements, like on top of a resource, or on the edge of another civilization's border.

How does the AI choose these sites? Should I take its advice into account?

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+1 Very good question. I've always wondered the same thing. I generally just ignore the AIs suggestion, although I think it is based on location to resources. –  Wipqozn Jun 28 '11 at 16:54
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I recall speculation that the AI suggestions might include "scoring" of resources that the player didn't yet have the technology to see, but I don't know if that was ever confirmed. –  bwarner Jun 28 '11 at 16:59
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up vote 12 down vote accepted

The AI city placement suggestions are based on the same algorithm AI players use to choose the location of their cities. This algorithm is not optimal of course, you can feel it when you conquer an AI civilization's cities and worry about their placement. It is outstandingly weak in using coastal cities, building cities one tile from the coast, even with a Financial leader (also resulting in a weaker navy and missing the health that Harbors give).

I think you should take the city placement advice of the AI as you would take any advice: a possible alternative. When you are deciding on the placement of your cities, you have to take several alternatives into account and weigh them, because city placement is vital.

Also, there are some strategical points that sometimes override general city placement rules. Sometimes, you just want to close down a bigger peninsula from the AI by putting a city in the enter point (and not having open borders). Sometimes, you want to get a strategical resource a few rounds earlier, so you put your city on the resource because that few rounds can mean a war won. Sometimes you can put the city in a location where it connects two oceans, giving you a quick route.

The AI city placement can be turned off as well, but I normally leave it on, just to see one more alternative I did not think of.

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