Maybe for large urban areas with many neighborhoods, micro markets.
Maybe there are models for cross linkage market to market.
Not sure it works for small communities or rural.
The urban model works if you can spread the overhead cost of print and distribution.
Free Newspaper Venture Depends on Local Blogs - NYTimes.com:
"The Printed Blog, a Chicago start-up, plans to reprint blog posts on regular paper, surrounded by local ads, and distribute the publications free in big cities."