The 33-year-old Swiss was in aggressive mood against his younger opponent, who was on a 28-match winning streak in China, and converted his third match point with a backhand volley to end a semi-final slugfest that lasted one hour 35 minutes.
Federer, who will return to second in the rankings on Monday, broke serve in the fifth game of the first set after a couple of unforced errors from the twice Shanghai Masters champion.
The 17-times grand slam winner, seeded third in Shanghai, broke again in the opening game of the second set and went on to exact sweet revenge for his defeat in their last meeting, at the Wimbledon final in July.
The 27-year-old Djokovic kept muttering to himself and appeared frustrated during the match but was effusive in his praise for his opponent.
"I think I did not play too bad," he said. "It's just that he played everything he wanted to play. He played the perfect match.
"I think he's going to tell you how he felt, but that's how I felt he played. He played an amazing match."
Federer hit 35 winners, four more than his opponent, committed less errors and faced just a single break point in the match which he saved.
"It was a great match, I agree," said Federer. "I think I played very well. There was nothing in the game today that wasn't working.
"I think it was a high-level match. I'm unbelievably happy with the way it went."
Earlier, Simon moved into his first Masters Series final in six years after outclassing Spaniard Feliciano Lopez.
The world number 29 faced little pressure on his serve and dominated the match from the baseline with some sumptuous groundstrokes to beat the 33-year-old Lopez 6-2 7-6 (1).
Lopez, who knocked out Rafa Nadal in the second round, netted a backhand volley to hand Simon the first break of the match in the third game and the tall Spaniard only had himself to blame as a double fault gifted a second break.
The frazzled world number 21 finally held to make it 5-2 but the Frenchman wrapped up the set in 25 minutes with an ace down the middle that swerved teasingly away from the left hander.
Lopez mixed up his tactics in the second set, opting to attack the net more to hustle his opponent, with some success but lost the tiebreak 7-1 owing to a mix of double faults, netted returns and wild smashes.
Federer has a 4-2 head-to-head record against Simon, whose only previous Masters Series final appearance came in 2008 in Madrid, and sounded a warning for Sunday's opponent.
"I'm not going to come into the match and play terrible," he said. "It just won't happen -- not in the finals, not against Simon. That's the confidence I have right now."
(Writing by Sudipto Ganguly, editing by Tony Jimenez and Toby Davis)
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