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Increasing plant density under insufficiency or deficit irrigation is considered a new water-saving technique in cotton production, especially in Xinjiang, China, an arid area with a short growing period. Increasing plant density reduces light intensity within the canopy; therefore, we hypothesized that resource use efficiency may be the main factor affecting cotton yield and water use efficiency under limited irrigation conditions. To test this hypothesis, 2-year field experiments were conducted to explore the effects of two irrigation patterns (I500, conventional irrigation; I425, limited irrigation) and three planting densities (D12, 12; D24, 24; D36, 36 plants m−2) on cotton yield, fiber quality, light interception rate, canopy photosynthesis and irrigation water use efficiency (IWUE). I425D36 raised yield and IWUE by 1.40–22.4% and 13.4–34.5%, respectively, but it did not affect fiber quality compared with other treatments. Further, I425D36 increased the leaf area index and the top- and middle-canopy light interception rates after 105 days after sowing, which improved the canopy apparent photosynthetic rate. Seed cotton yield was associated with leaf area index and the top- and bottom-canopy light interception rates. We conclude that irrigation of cotton with limited irrigation at a 425-mm level and a plant density at 36 plants m−2 had significant benefits in terms of economized irrigation without reducing yield in arid areas.