I's a real time auction system, so yes they are.You got something for nothing that you used to bid against people who have to pay the full value. But they're probably operating within legal bounds. Have no idea about legislation, but just like coupons in the retail world, there probably are some legal bounds.
But you identified exactly the main problem of the AdWords model. The unpredictability. Imagine this. You have a business and the main method of customer acquisition is these ads you bid on. You can get good at operating it at a profit. Bid just the right amounts, so you're making the right margins. Life is great.
Then all of a sudden, it stops working. Grinds to a halt. You rush to your machine to see what's wrong and the price is now insane. No way you can make a profit. And it can be caused by two extremes. Either someone is really dumb and doesn't know the real value of those specific keywords, and drags you down with him, or you just got a competitor who's massively funded and can afford to throw big money around. Either way, not the best situation to be in.