I think that there is potential here to lose your customers anyway, the younger ones may be so embaressed by the mil that they may not come back to you.
If it was my MIL that did that, I'd be embarrassed either way, but would feel worse if my MIL had brow-beat "my cake lady" into a refund. I would feel ashamed to face my cake lady knowing that she'd been "cheated".
I have an aunt like this, so I've kinda experienced this in my younger days. 
I realize you have a chance to lose your cust but if the DIL is sensible she knows who to blame. You are still a business woman and need to stand by that to be treated like that.
I really stand by what I said earlier: don't run with their money; offer 100 cuppies as per the agreed price and move on.
In the future don't undersell yourself either g/f. It's an easy mistake to make when you have reg customers but not worth it. Why? People at the shower are eating yummy cuppies and DIL says "They were only $3 each too!". Guests call you. You either give $3 cuppies to the world or explain why they don't deserve the same price.
In the end your good deed lowered the market price for the immediate group, even if it was just in their narrow minds, and probably lost sales. Why lost sales, you say? If I expect $3 cuppies and they are now $5, I'd move on. I'd look for a damn $3 cuppy. If, however, I expected a $5 cuppy, I'd be satisfied when quoted $5.
The MIL will never be your cust. If the DIL is reasonable she will blame herself and not you; even if she doesn't admit it at first.
100 cuppies!
Let me share a story about a biz who did it "right", that is similar to this.
I was in my local rental place, placing my order for the linens and plates I would need that weekend. A guy was in there wanting his money back for one of those bouncy things for kids that he'd rented the previous weekend because they couldn't figure out how to set it up so it basically wasn't used.
Woman behind the counter was VERY calm and very professional as she explained that when his wife made the arrangements, it was explained, and she signed off on, the information about the rental place's set up fees but she decided to not pay those (our equivalent of delivery?) because she'd save the sixty bucks and "the guys" could do it. Husband was arguing that she didn't know what was involved and the unit wasn't used. Clerk said too bad. This was a popular unit and they turned down other requests for it because "it was rented to you", so they lost income from other sales (our equivalent of "I closed this date to other brides just for you"). guy kept arguing but clerk was calmly and professionally holding her ground, reminding guy that they don't collect money if its used or not .... they collect money when its rented.
It's not personal ..... its business.
so here's an update....the couple called me a few minutes ago and said they would pay me for the cupcakes because they don't want to go elsewhere adn they don't have a problem with my price. I am really scared to do it now, especially as the MIL will be there and I know she will try to make me look bad...oh and to make matters worse the couple gave me an invitation to the baby shower. (should I go to the shower?, should I make the cupcakes?)
Be strong and make the cupcakes. You entered into a contract, the couple are upholding that contract and now you need to show what a good, strong, confident, business person you are. Definitely do the cupcakes. As for the shower, you could always back away saying you have other orders you have to work on, but maybe send a small gift if you feel up to it. You have good customers in this couple, and just think how you can get back at the MIL if you send a small gift and she then tries to badmouth you. lol (just the evil side of me coming out)
Oh, and thank you for the update. I think we all wanted to know what was going on.
Oooooooh, I'd go and very sweetly offer MIL a cupcake (that's my evil side coming out).
Seriously, very happy for you that you didn't lose the order or your customers, you've handled it well. Maybe MIL is just a whackjob and they are used to her??
Do the order and thank them for the invite, but dont go to the shower. Might I suggest adding a 6in cake to the order and add that flower with the baby figure in it onto that? After all, you were going to "gift" the baby and flower to them anyway. At least if it's on the 6 in "gift cake" there will be no doubt that you did that part for free.
Also, I would like to point out that sugardugar had a good point about the cupcakes being a "hit" at the shower and the DIL stating to everyone "yeah, and they were only $3 !!" I would definitely tell the customers that you have discounted your pricing "because they are such good customers and you wanted to do something special for them for their baby shower" However, you would appreciate it if they not disclose pricing to any of their guests. That you would definitely appreciate the word of mouth advertising, but since this is not your typical pricing, you would hate to upset any new customers were they to contact you requesting $3 cupcakes and you would have to quote your regular pricing....anyway, just a suggestion.
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