That the setting is "bad" for these characters is something of an understatement, I would argue. I mean, let's be honest, choosing to bring up your family next door to a concentration camp isn't going to be the most popular choice for people in terms of their "dream home." In particular, you might want to focus on the way that the mother responds to the reality of living next to a concentration camp and how she withdraws from life as a result.
Of course, the major impact is on Bruno, and as we see the story through his eyes, we can see the way in which his childlike point of view misinterprets massively what goes on around him and how he develops a rather skewed picture of reality. So much of what we as adults can see as the truth is skewed and misperceived through his innocent gaze which leads the story to its tragic conclusion. Bruno is unable to believe that his father could be involved in something like a concentration camp, and so the idea never enters his mind. The setting places Bruno and his family into contact with direct evil, and they all respond in different ways as they try to come to terms with this.