Laboratory observation, as opposed to naturalistic observation, refers to observing the behavior of subjects that are in a controlled environment. Because of the controlled environment variable factors can be controlled which therefore leads to a limited number of possible responses. The experimental settings are more controlled. Measuring devices can often be used more easily and more efficiently.
For instance, observing children in a classroom setting you will have children sitting down, listening to a teacher, or doing classwork. However, observing children on the playground at lunchtime you will see children outside of the controlled environment interacting and behaving in in a wide variety of different ways due to the freedom of the naturalistic setting.