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In addition to procuring energy, consumers in electricity markets procure demand response (DR) services. Demand and supply of energy in the electricity market drives the demand for DR services. Through the net benefits test (NBT), economic procurement of DR is limited to an amount that ensures that consumers benefit with the procurement of DR services. However, the NBT neither a) recognizes the coexistence of the DR market with the energy market; nor b) optimizes social welfare in the DR market in concert with that of the energy market. This lack of accounting for DR market surplus results in economic inefficiency. To address this shortcoming, we advance past works by: a) proposing a real-time DR market where the DR demand curve is a function of opportunity in the energy market; and b) co-optimizing energy and DR markets such that the total social welfare derived from both markets is maximized simultaneously. We also present an optimal power flow formulation and process to implement our ideas in real-time electricity markets. The formulation is tested on a simple test case and a system based on actual Pennsylvania-New Jersey-Maryland (PJM) data. For the PJM case, total social welfare is increased by 1.41% to 3.05% over existing DR procurement strategies, resulting in $14.5M to $30.9M additional benefits per hour.Index Terms-Demand response, optimal power flow, power system economics.

<p> This study presents a new market-driven and transparent pricing mechanism for demand response (DR) that ensures social welfare is maximised. The existing methods have DR priced at the electricity market clearing price (EMCP), where the EMCP is determined in a market solely comprised of aggregated generator price bids and demand bids. DR supply bids are not included in the current economic market model, resulting in inefficient markets. The authors also present a new metric, Actual Price, which captures two key elements missed by EMCP: (a) the price paid to DR suppliers (EMCP covers only the price paid to generators); and (b) the reduced pool of paying consumers when DR suppliers leave the buyer pool. An implementable process for DR planning using the authors’ new concepts is presented. Results are shown for systems with and without location pricing. The results demonstrate that the proposed DR procurement method yields lower Actual Prices than existing methods and results in savings for customers. These ideas can guide regulators in determining market-based pricing policies for DR as well as Independent System Operators and system operators in determining DR procurement levels.</p>