A very odd bug and rather difficult to reproduce. But here is the best I can do. The zip contains a save where the next turn the city will level for you.

https://dl.dropboxusercontent.com/u/75549875/Fallen%20Enchantress/CityUpgradeNextTurn.zip

When the city levels,

Then I double click on the information side of the screen, specifically you have to double click on a resource in the background... tricky part as they are hard to see.

Once you do this a sound will play the screen will close and the background item is selected. The "leveled upped" city is now a level 2 village.

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Sum up --

Level city

double click on resource in the background of the level up screen

screen will close and city is a level 2 village.

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The Pics - spot to click

The Result