China has become the country with the largest total energy consumption nowadays，and is also one of the largest county of coal reserves, coal-fired power generation capacity and electricity production in the world. Chinese regional electric power market structure, which seems to be oligopolistic competitive one, shows an important characteristic in the process of the market-oriented reform of Chinese electric power system. For thermal power firms such as coal-fired plants（CFP）, one of the most important production decisions to make is how to allocate the operating costs among fuel costs, innovation expenditures for energy saving and those for environmental protection in order to achieve firms’ maximum profits and reduce pollutant emissions as well. The purpose of this paper is to study the market equilibrium, its influence factors and welfare implications of those decisions, and to show the policy implications which may throw light on the market-oriented reform of Chinese electric power system at present.  Based on D’Aspremont & Jacquemin (1988) classic model, we build a two-stage dynamic game model to examine CFP’s decisions in an oligopolistic market structure. On one hand, our paper both considers the firms’ innovation cost and technology spillover in the basic model. On the other hand, different from previous studies, we distinguish the heterogeneous innovations, according to the different innovation mechanism between energy-saving innovation andemission-reducing innovation in every CFP. This paper assumes that energy-saving innovation which reduces the marginal production cost and increase the firm profit would directly affect the CFP’s decisions, and this kind of innovation would also lower the resource consumption and be beneficial to the sustainable development of the economy. But for emission-reducing innovation, the environmental protection measure applied by the CFP necessary to the whole social welfare would reduce the short-run profit of the firm. Based on these two kinds of innovations above we construct the cost function of the firm in our dynamic game model. We solve and discuss CFP’s optimal innovation investment and optimal output of the dynamic equilibrium under three different typical competitive strategies respectively, examine the effects with respect to the ratio of innovation investments for energy-saving and for emission-reducing and the degree of technology spillovers. The main finding of comparative analyses is: (1) the optimal innovation investment and optimal output of the dynamic equilibrium both increase while the ratio of innovation investments for energy-saving and for emission-reducing grows. (2) the optimal innovation and optimal output of the dynamic equilibrium may both be impacted by the degree of technology spillovers but in different directions. We analyze the social welfare by comparing each equilibrium level of innovation and output under three different social welfare functions. First we define three kinds of social welfare functions respectively, (1) considering only the consumer surplus and the producer surplus, (2) consideringthe consumer surplus, the producer surplus, and the level of emission-reducing innovation, and (3) considering the consumer surplus, the producer surplus, the level of emission-reducing innovation and its spillover. The social welfare criterion we set is the distance from the social optimum level of innovation and output corresponding to the relevant social welfare function to the innovation and output of dynamic equilibrium with three different typical competitive strategies respectively. The finding of welfare analysis is that, no matter whether it is for the final product market or for the innovation one, considering innovations and their spillover channels of different kinds, more competitive market brings greater social welfare. This conclusion is not exactly the same as D’Aspremont & Jacquemin (1988) shows.