when a manufacturer sets the sales price of a product the firm takes into account the costs of labor material and overhead the sales price must include the total costs incurred if any costs are left out of the sales price calculation the amount of profit is lower than expected if demand for a product declines or if competition forces the business to cut prices the company must reduce the cost of labor to remain profitable to do so a business can reduce the number of employees cut back on production require higher levels of productivity or reduce other factors in production cost 
in some cases the cost of labor can be shifted directly toward the consumer for example in the hospitality sector tipping is often encouraged allowing businesses to reduce their cost of labor the differences between direct and indirect costs of laborassume that xyz furniture is planning the sales price for dining room chairs the direct labor costs are those expenses that can be directly traced to production xyz for example pays workers to run machinery that cuts wood into specific pieces for chair assembly and those expenses are direct costs on the other hand xyz has several employees who provide security for the factory and warehouse those labor costs are indirect because the cost cannot be traced to a specific act of production examples of fixed and variable costs of laborlabor costs are also classified as fixed costs or variable costs for example the cost of labor to run the machinery is a variable cost which varies with the firm s level of production a firm can easily increase or decrease variable labor cost by increasing or decreasing production fixed labor costs can include set fees for long term service contracts a firm might have a contract with an outside vendor to perform repair and maintenance on the equipment and that is a fixed cost factoring in undercosting and overcostingsince indirect labor costs can be difficult to allocate to the correct product or service xyz furniture may underallocate labor costs to one product and overallocate labor costs to another this situation is referred to as undercosting and overcosting and it can lead to incorrect product pricing assume for example that xyz manufactures both dining room chairs and wooden bed frames and that both products incur labor costs to run machinery which total 20 000 per month if xyz allocates too much of the 20 000 labor costs to wooden bed frames too little is allocated to dining room chairs the labor costs for both products are incorrect and the sale prices of the two goods will not reflect their true cost cost of labor vs cost of livingwhile the cost of labor refers to the sum of all wages paid to employees it should not be confused with the cost of living the cost of living is the cost needed to maintain a certain standard of living by a consumer in a specific geographic location this includes housing food transportation entertainment etc these rates can sometimes be much higher than the cost of labor especially in highly metropolitan areas for example the cost of living is higher in new york city than in a suburban city demand for housing and food is higher which means higher prices for consumers 