I'm sort of in the same boat, although, not married, no plans for kids. I'm basically between a good firm with a non sweat shop rep in a big market and a lifestyle firm in a smaller market. It is good that we have choices, but it doesn't make them any easier.
Honestly, if you decide on the secondary market, I think option 3 is better than option 2. You feel like you will fit in. You liked everyone you met. You have a family and they have less of a sweatshop reputation. The layoffs are scary, but if they are in a practice area that is cyclical and you don't have interest in (real estate for example) then you might be OK.
If you have real trouble, you can try what I did. Make a list of things that are important to you in your job. Weight each one so the sum of the weights is 1.00. Then, for each firm give a score of 1 - 10 for each category. Multiply each score by the weight for that category. Sum each category for each firm. Highest score wins. For example:
Like People (.25)
QOL 7, 7*.5 = 3.5
Like People 7, 7 * .25 = 1.75
City 10 * .25 = 2.5
Total = 7.75
QOL 10, 10*.5 = 5
Like People 8, 8 * .25 = 2
City 5 * .25 = 1.25
Total = 8.25
Firm B wins.
This is a technique we used a lot in my old job when we had to make important decisions. They were much more complicated, but the process was the same. It sounds like a lot of work, but it can really help put things in perspective. You might even make a decision while you are making up the list as to what is important to you.
Of course, when I did this, the scores came out exactly the same.
I think, in your situation, the last thing you should be thinking about is firm "prestige." While it may be a factor, I think you and your family's happiness ought to come first.