Hal Varian, the Chief Economist at Google explains in a most excellent way, the way that Google AdWords determines ranking factors when you are bidding on keywords.

Hal explains that advertisers want to show relevant ads (most of the time), users want to see relevant ads, and Google wants the best for both advertisers and users.

Hal explains how the maximum Cost Per Click (CPC) is not necessarily what the advertiser will pay.

Hal continues to explain quality score. The most important factor is Click Through Rate (CTR), followed by relevancy (how well ads relate to keywords bid upon), and last, the landing page quality in relation to both ads and keywords bid upon.

Quality score ensures that the most relevant advertiser is ranked first and therefore gets the most visibility. Quality Score also ensures that the price paid per click is reduced for the most relevant advertiser.

Watch the video below for a clear, precise explanation: