Madcap Mode is opened after after you defeat the final boss in Loonyland 2. It is identical to the normal game except all of the monsters have had their level boosted by 50. (except Caravans.) This has the upshot that you will earn a lot more experience, but the monsters are a lot more difficult to defeat. The actual stat modifiers are HP*30, Armor*5, Damage*10.
Madcap Items Edit
In Madcap Mode, a new menu opens up under the pause menu, labelled "Madcap Items." These crystals improve your spells, axe and defenses far beyond the levels available in normal mode, but get exponentially more expensive, both in terms of Crystals (earned by getting 1000XP) and money.