Time Machine backs up your entire drive (excluding the things you choose to exclude) on the first time you run it.
After that, it then copies over only those files that have changed.
If you have a 500MB file, and you change its name, it will be copied again. If you change its name again, you will have 3 copies of that file.
Most files on your computer do not change. A lot of the System files and Applications, for instance. Your iTunes files are unlikely to be modified.
Ideally, you want more space than is USED on your hard drive.
TM will delete old backups if the backup drive is full.