A bid is the maximum amount of money you’re willing to pay for your ad to show up for a certain keyword. Google AdWords uses an auction-like bidding system to allow competitors to “outbid” each other for different keywords. The higher your bid, the more likely your ad is to show up. However, in practice, you only have to pay enough to beat out the next highest amount. For example, let’s say you and a competitor are bidding on a keyword. Your bid $4, and theirs is $1. In this (very oversimplified) situation, you would only have to pay $2 for your ad to show for that keyword.
This doesn’t mean that the best strategy is just to bid higher than all your competitors. Google also looks at the overall quality of your ad and its relevancy to the keyword (your Quality Score) as a factor in deciding which ads get shown for certain keywords.