Abstract: Based on the micro data of the industrial enterprise database published by the National Bureau of Statistics from 2005 to 2007, this paper studies the mechanism of how market competition and demand scale impact on the technological innovation of Chinese enterprises. We find that the impact of market competition and the scale of market demand on an enterprise’s investment in technological innovation takes on an inverted U shape. This paper uses enterprise (industry) profitability indicators and industry concentration of 5 companies to measure the degree of market competition, and finds that only in competitive markets dominated by large companies (i.e, about 60% of the market shares are taken by top 5 companies whose gross profit margin keeps stable at around 34%), enterprises have the highest intensity of technological innovation, too much competition or lack of competition are not conducive to technological innovation. We use the enterprises’ total industrial output value, main business income and sales income to measure the market demand scale. We find that when the scale of demand is too small or too large, technological innovation is not active; only when the market demand scale is stable at a certain mediun high level, enterprise technological innovation is the most active. At the same time, the innovation of large enterprises is both demand-driven and competition-driven, while small enterprises’ innovation is driven mainly by competition. There is a positive correlation between advertising investment and enterprise technological innovation investment. This paper puts forward several policy recommendations: Firstly, pay full attention to the unique huge market size of China and create competitive markets in various industries and allow large enterprises to compete and obtain a considerable market share and profitability. Secondly, continue to support and optimize tax incentive policies to encourage technological innovation. Thirdly, make larger efforts to optimize and improve enterprises’ marketing capabilities.

Key words: firm innovation, competition degree, market demand, demand-driven, competition-driven