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Label is not same as creating folders in other Services. In gmail if you label any conversation you are puttind an extra tag to it. In layman terms it will mark that conversation with the label. It will not make any folder named label and place you conversation into that.So instead of deleting the conversation just archive it so it will not be shown in Inbox but it will remain in labels.
In technical terms :
Lets us suppose that Google maintains a huge database for all the mails it gets.
The primary key is obviously user name. It may have several other fields like starred(Y or N), label( label name ) etc etc etc....... This is just a guess. So when you label any conversation that field is updated with that "label" and you see you convestaion that label group. Same thing will be used if you star any conversation. The field will be updated to Y and a star will be shown with all such conversations.
I hope u understood..
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