Yes, 40% of the U.S. corn crop now is used for ethanol, but this has been accomplished while still meeting traditional food, feed, and export demand. The ethanol buildout was feedstocked by higher production, and corn yields continue to increase. People in the business expect national average yield to reach 200 bushels an acre in the mid-term, and higher down the road. The current winners in the annual corn yield contests are commonly over 300 bushels an acre, which is ten times the average yield at the end of WWII.
From the farmers' standpoint, a bushel of corn converted into ethanol and DDGS is significantly more valuable than the same bushel sold as feed. Prices are volatile, but just to toss out some ballpark numbers, if commodity corn is $4.75 a bushel and the same bushel converted to ethanol and DDGS is $7-7.50, the choice is pretty clear.
From a motorist's standpoint, ethanol reduces the cost of gasoline by providing a cost effective competitor to petroleum (which is why the oil industry hates ethanol). At a 10% blend, ethanol will reduce mileage because its energy density is lower than gasoline, but at higher blends, the mileage penalty would disappear because the octane boost would more than compensate. But that would require evolving towards E30 or E40 blend levels, which is a long term proposition. If third generation feedstocks (e.g. algae) hit a suitable price point, however, I would expect this to happen fairly promptly.
Octane and BTU's are two very different things.