Why is this a good thing? Shouldn't we be striving for a merit based system and not a system that benefits the few people that are able to get through the YC interview process?
I'm not sure what you are calling for here. The YC interview process is a merit-based system.
It doesn't matter who you are, where you went to school, or what family connections you have. It's an open application available to anyone in the world to sell some venture capitalists on the merit of your ideas. How does it get any more merit-based than that?
I'm sure those things do actually matter(family connections could turn into a Friend's and Family round; the school you went to could mean you learned how to hack when others didn't).
I am not an insider, but I view this as, "Starting something is hard. We make it a little easier for you. You make it a little easier for the next group."
There are so many random things that can befall a startup, that any support network is great. This is no different than Steve Jobs mentoring people, because others mentored him.
It doesn't matter who you are, where you went to school, or what family connections you have. It's an open application available to anyone in the world to sell some venture capitalists on the merit of your ideas. How does it get any more merit-based than that?