If people use dwarves, then it’s correct to use it regardless of origins.
It’s the same thing with the whole octopus plural thing. Both octopi and octopuses are completely correct despite octopedes technically being the right answer.
Many people (who don't actually study language or the evolution thereof) jump to a Prescriptivist viewpoint at first. Dictionaries follow actual English usage, not the other way around (Descriptivist).
I can't fault you; in order to teach English a prescriptivist mindset naturally has to be applied. So we teach Standard English's rules.
However, go compare various English style guides and tell me if they are the same.
Dwarves & Octopi are correct, because that's what people use. If octopedes was used instead, it would be correct and it wouldn't have a red squiggly line.
Even those who most joyfully embrace the flexibility of language need to be largely linguistically conservative else the meaning of a sentence is lost (consider Lafferty's story where the language changed every day -- Nine Hundred Grandmothers IIRC).
And in that list your condemnation of "correct" is itself conservatively prescriptivist as I have always read it (in this context) as a a shorthand extension of "typically customary" or "etymologically consistent"