I think some people project their concern on smaller schools and its somewhat condescending. I am not even sure what you are considering JV - if Penn has 3 varsity teams, are the 2nd and 3rd teams JV, or is the fourth string JV? Is it just semantics? If the 2nd and 3rd team are competing at a varsity level, why are they not varsity? If we are trying to grow the sport so that someday there are more coaches, referees, and families that want their kids to wrestle - wouldn't having 3 teams of kids from 1 school competing and having fun make the most sense? That should spread outside school boundaries as kids graduate and move on in life and benefit more than just large schools.
A loss will not feel good no matter who beats you. To me, we should stop trying to protect kids from losses and start teaching them that losses are big opportunities to learn and grow. Losing to a 2nd or 3rd team kid could be more helpful than getting pinned in 30 seconds by the 1st team kid because they have a chance to compete with that kid at least. Removing good kids from competition hurts both the 2nd team kids and the kids who would have lost to them because the kids who would have lost do not learn anything from winning a weaker tournament.
Coming from a small school just means kids have different goals sometimes. Making it to state or winning regional means just as much to a kid from a small school as winning state does to other kids. Its about reaching your potential and doing the best you can, not just where you place. If you want to improve the competition in the state, don't take opportunities to compete away from either side.