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The current genre of contemporary realistic American novel aims to show the real life experience of American youth. This genre has expectations that setting, action and events reflect what students regularly witness and participate in in school and in their neighborhoods. This includes street gang warfare, thefts, assaults, school shootings, drug overdoses, alcoholism, drunken driving and every other sort of evil our contemporary American society is currently criticized (and condemned) for.
Thus, while it is too narrow and limiting by far to suggest that the only settings might be brothels, prisons or tenements, it is certain that these setting are much more suited to the grizzly genre and more likely to appear in a contemporary realistic American novel than a sweetshop. Though, to speak realistically about the contemporary realistic American novel, there is no reason a sweetshop might not be an incidental setting in a novel of this genre because even gang memebers go to schools that might have sweetshops across the street and even criminals might get a longing for a chocolate fudge milkshake. The genre differentiating elements would be (1) what havoc might occur in the sweetshop to perhaps turn it on end or rob it or (2) what might happen outside the sweetshop to maime or murder someone, perhaps a drive by shooting, since violence is also an expectation of the genre.
Having said all this to put setting in perspective with characters, events, and actions, the answer to your question as posed by your teacher is, as you correctly deduced, answer (b): a brothel, prison or tenement. I expect now you can recognize why and can understand how setting must work in concert with characters, actions and events.
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