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Recently Hal Varian, Google Chief Economist, explain in Google Blog of how the search engine define the process of keyword pricing, heres the excerpt of  5 (Five) Step of Pricing Process

1. Each advertiser enters a list of keywords, ads, and bids.
2. When a user enters a query, Google compiles a list of all the ads whose keywords match that query.
3. The list of ads is then ordered based on the bids and the Ad Quality Scores, which measure the relevance of the ad to the user.
4. The highest ranked ad is displayed in the most prominent position, the second highest ranked ad gets the second most prominent position, and so on.
5. If the user clicks on an ad, the advertiser is charged a price that depends on the bid and Quality Score of the advertiser below it. The price charged is the minimum necessary to retain the advertiser’s position in the list.

This process is really important to learn if you serious on PPC advertising, so make sure you aim for low pricing keyword, or high on price but worth it.

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