In liberalized power system, the distribution companies are free to choose the contracts with all available generating companies (GENCOs), while the independent system operator acting as regulatory authority. In this article, the liberalized automatic generation control problem is studied for a two‐area interconnected power system. The studies are divided into two parts. In first part, the investigations are carried out with only thermal generations in each area. In second part, the multi‐diverse sourced thermal‐hydro‐gas GENCOs are assumed in each control area. For damping out the system frequency and tie‐line power dynamics, the popularly known PI and PID controllers are employed considering poolco, bilateral and contract violation transactions. In both the parts, the comparative performance between PI/PID controllers is made. Studies reveal that PID outperforms PI controller. A case study with introduction of time delay in the system is performed as the open communication infrastructure introduces inherent time delay in the smart grid scenario. To understand the impact of frequency sensitive loads on system dynamics, the effect of variation in damping coefficient (D) is studied and it is shown how the D is influencing the dynamics. The effect of double reheat turbines is also studied and found that they deteriorate the dynamics when compared to single reheat turbines. In all the above studies, the powerful nature inspired firefly algorithm is employed to optimize the parameters of controllers using the integral squared error method.