Learn Icelandic: Sveitarfélagið takmarkar þessa staðbundnu þjónustu. Gerir það það? - The municipality limits this local service. Does it?

The first það is the subject 'it', replacing the neuter noun Sveitarfélagið. The second það acts as the object, representing the action of limiting the service ('it' or 'that'). When echoing a statement with an action verb, Icelandic uses gera (to do) and requires an object, so you literally ask 'Does it do that?' rather than just 'Does it?'.

Why does the adjective staðbundið take the weak form staðbundnu here?

It is triggered by the demonstrative pronoun þessa (this). In Icelandic, just like a definite article, a demonstrative pronoun forces the adjective that follows it into the weak declension.

Why is the phrase þessa staðbundnu þjónustu in the accusative case?

It is the direct object of the verb takmarka (to limit), which governs the accusative case. The pronoun, adjective, and noun all agree in the feminine singular accusative form.

What are the root words that make up Sveitarfélagið?

It is a compound of sveit (countryside, district or municipality) in its genitive form (sveitar), and félag (association or society), plus the neuter definite article -ið.