As other answers have stated, you need a reason (preferably more than one) why the dragon is tolerated, or your situation will not survive. Given that dragons in that time period are generally seen as raiding farms (disastrous to the peasants), hoarding treasure (sure to draw enterprising thieves), or even stealing away virgin princesses (sure to infuriate their families), that's a problem.
You're going to be requiring an active benefit to having a dragon around, and it needs to be a significant benefit; otherwise, even if the villagers are willing to bribe the dragon not to attack them, dragonslayers will gladly line up to take their shots at the dragon. You need to give the peasants a reason to actively try to keep away such problematic people.
This one I'm mostly outlining to point out the pitfalls. You might be able to threaten the village into compliance, but that doesn't stop those roaming dragonslayers from making their attempts. The dragon might threaten that such attempts would automatically be blamed on the village, but that would just have such slayers make sure to avoid the town; some might care about the consequences of failure, but others will not think that far ahead or just not care, and of course some will be so confident that they never consider such a silly possibility as getting killed.
Perhaps dragons are the only accessible source for (insert valuable thing here). If dragon scales are valuable, for instance, the dragon might offer up its loose scales as they fall out, giving the locals a convenient reason for a trade hub to develop. Sure, you could kill the dragon and get an immediate harvest, but that's dangerous, and it only works once: a continuous supply of scales is more profitable in the long term, especially since you avoid flooding the market and thus keep prices up. This proposition basically relies on having some rational long-term thinkers on both sides of the negotiating table; it can work, but if you don't have means to enforce it there will inevitably be some idiots trying to muck it all up.
If your world has magic, you can pretty much make up whatever you want here, and bonus points if it only works while the dragon is still alive. It makes for a lovely excuse as long as you can get your valuable magical ingredients without serious injury or death to the dragon; loose scales, a horn falling off, perhaps a few teeth or claw-tips, or even the waste it leaves behind!
This is likely your best bet. The dragon isn't going to want others spoiling his tidy little arrangement, not if he's got an easy time living off what the local peasants offer him. He's going to be defending that arrangement against unwanted interlopers of all sorts, whether they be dragonslayers or armies or other dragons; it makes a perfectly natural proposal, really.
This actually gives you something pretty close to standard feudalism: you're substituting a dragon for the knight/noble/king (depending on the size of the town), but the basic principle still holds up. The peasants feed the dragon (attendants/guards for the dragon optional) and keep aspiring dragonslayers away, and in return the dragon ensures the peasants can go about their lives in safety. There's lots of ways to go with feudal dragon-nobles like this: I can practically see a story writing itself as I type.