Makhloufi lined up at the start of heat five at the Olympic Stadium on Monday morning but stopped at the end of the back straight and wandered across the infield past the pole vault area.
The International Association of Athletics Federations (IAAF) referee subsequently banned him from the rest of the athletics programme for not providing "a bona fide effort".
The Algeria team, upset that the IAAF had not spoken to Makhloufi, said the athlete had a knee injury and the decision was later reversed on medical grounds.
"After reviewing evidence provided by the LOCOG medical officer, the disqualification of (Taoufik Makhloufi) from further participation in the athletics competition of the 2012 Olympic Games has been revoked," the IAAF said in a statement.
The 24-year-old had been obliged to run in the two-lap race after his team neglected to withdraw him by Sunday's deadline, an IAAF spokeswoman said.
Makhloufi stormed past Olympic and world champion Asbel Kiprop in a stunning finish to win his 1,500 semi-final in three minutes 42.24 seconds on Sunday, marking him out as a possible title contender.
Makhloufi, the African champion in the 800, has shown a marked improvement this year, bringing his personal best down from 3.32.94 to 3.30.80 in the 1,500.
The exclusion was the latest in a string of incidents at the Games where athletes have been accused of not trying to win in order to manipulate results or draws in their ultimate favour.
The worst was the badminton fiasco, where eight women from China, Indonesia and South Korea were thrown out of the Olympics for playing to lose group matches in order to get a better draw in the knockout stages.
There have been other incidents which have not drawn any punishment, with organisers deciding that spectators had not been denied a competition.
French rider Mickael Bourgain quit the cycling road race after just a few kilometres as planned on the first weekend of the Games having been forced to take part in order to compete in his favoured keirin track event.
Last Thursday, teenage cyclist Philip Hindes appeared to admit he deliberately crashed in cycling's team sprint event to ensure Britain were handed a restart because they set off badly.