AdWords is a pay per click system that allows you to bid on various keywords. The results show up in the Sponsored Listings on top of Google.com.
So if you want to rank for "flannel pajamas" then you will bid on that keyword phrase with other advertisers.
Google then ranks the ads based on the bid price and overall landing page quality score.
Every time your ad gets clicked, you are charged by your bid price. So if your bid price is $2.00, 20 clicks will cost you $40.