Tanks, helicopters, jet fighters and naval ships were involved in the exercise, which comes at a critical juncture in US-China relations.
Taiwan also unveiled a new multi-barrelled rocket launcher, called Thunder 2000.
A decision is expected from Washington next week on the sale of new weaponry to Taiwan.
Meanwhile, Beijing is refusing to hand over a US surveillance plane forced down in China on 1 April.
The BBC correspondent in Taiwan, Damian Grammaticas, says the military manoeuvres are a reminder that Taiwan still feels threatened by China and says it needs advanced US weapons to defend itself.
Beijing considers Taiwan to be a renegade province.
Simulated invasion
On Haiko beach in southern Taiwan, combined army, navy and air forces fought off a simulated Chinese landing.
An artillery barrage pounded targets in the sea. Taiwanese-made missiles were launched from land batteries and helicopters fired Hellfire missiles bought from the US.
The show of firepower was part of a series of exercises that include simulated computer battles and cyber-warfare tests.
Similar war games last year were scaled down for fear of provoking China.
Decision due
The BBC's Paul Reynolds in Washington says President George W Bush is considering a recommendation that the US should not sell advanced destroyers to Taiwan.
Senior defence officials are reported to have said that Taiwan should not at the moment be given the four destroyers equipped with the Aegis anti-aircraft and anti-missile system, but that it should have less sophisticated destroyers instead.
The advice is expected to be taken up by Mr Bush's national security advisers.
The Aegis destroyers are the most advanced weapons on Taiwan's list and their sale has been strongly opposed by the Chinese Government.
The defence officials reportedly also oppose the provision to Taiwan of the latest American land-based missile defence system known as PAC-3.
US balancing act
The issue of whether Taiwan should get eight to 10 diesel-powered submarines has been left open.
Under a 1979 law, the United States is committed to providing Taiwan with weapons for sufficient self-defence.
There is an annual procedure to examine which systems should be made available.
Washington needs to balance meeting its commitments to Taiwan without unduly upsetting Beijing.
With the two countries still at loggerheads over the US spy plane Beijing is holding, this year's balancing act is proving particularly difficult.