As a city gets bigger, unhealthiness and unhappiness occurs due to overpopulation.

Do the towns we build around the city actually provide solutions to this, or merely provide a money bonus?

Surely the idea of them being worked is reflecting people living in the towns commuting to the city.

But wouldn't that mean then the city would decrease in population slightly? Since now people are migrating out to the 'countryside' so to speak?

Is it possible to have cottages decrease happiness to overcrowding or, atleast, decrease overpopulation?

I don't think it's possible at the moment, but it's a good idea. I think I saw GRM7584 suggest a while ago that they also should be able to add culture and happiness. It's probably not something that will be going into the standard game, but it would be nice for us poor modders.

That would be cool if towns could give +1 :D.

I have no idea if cottages can be modded so, however.

i looked in the xml files and couldn't find a happiness tag. However it must be dooable in python as forests provide health and happiness (in environmentalism at least.)