Abstract: At present，the problem of overcapacity is still serious． The research on market mechanism of capacity allocation is the key to promote the organic combination of market and policy to promote high － quality economic devel- opment． Based on the panel data of China＇s iron and steel industry from 2003 to 2017，this paper constructs a double e- quation of capacity utilization and capacity allocation，and empirically analyzes the different mechanisms of the impact of demand shocks on capacity allocation． Firstly，when the demand shock is divided into expansion and decline，it is found that the impact of demand expansion and demand decline is asymmetric． Secondly，the threshold model is used to divide the demand shock into three stages． It is found that the impact of demand expansion on capacity allocation level and capacity utilization is nonlinear． The results show that the rapid evolution of market demand is an important cause of overcapacity． The high － speed expansion of market demand is more likely to cause excessive capacity entry，but through the market regulation mechanism can not guide capacity exit． Therefore，in the process of governance and pre- vention of overcapacity，we should avoid a single regulatory policy，and develop different strategies to deal with the problem of overcapacity in combination with different mechanisms of demand shocks．