The money flows as so:
Advertiser pays ==> Google ==> Publisher
The publisher in this case is the website upon which the advertising appears. This could be you if you choose. In any case the advertiser pays an amount per click, Google takes a cut, and you get the rest.
What determines the rate? Google doesn't really say, but it's clear there's several attributes to this:
- Page views are the demand side, and they come either from Google searches or viewing pages on web sites displaying Adsense advertisements.
- Advertisements are the supplier side, and they come from Adwords advertisers.
- The number of places advertisements can be displayed is the size of the playing field.
In essence it is a simple supply/demand situation. You have a certain demand for advertising based on some keywords. The keywords are coming either from google searches, or from web pages viewers (in the latter case, the keywords are derived from the topic of the web page). Google seeks to fill that demand by providing advertising from its inventory from Adsense advertisers.
When an Adsense advertiser places an advertisement, they declare two things. The first is the list of keywords for which their advertisement is relavent, and the second is a maximum Cost Per Click (CPC) they are willing to pay. They also declare a total cost per day they're willing to pay. What they are competing for is relative positioning within the advertising displayed on pages, because the closer to the top the advertisement is shown, the more successful the ad will be.
Essentially this means that hot items, that are frequently searched for, will often have the highest CPC, because of the huge demand.