This study investigates the impact of incentive‐based demand response on the optimal economic sizing of hybrid power systems for a remote area in South Australia. The hybrid power systems are modelled as AC‐coupled system with various power generation and energy storage systems including diesel generators, solar photovoltaics, wind turbines, battery storages and flywheels. Operating reserve requirements are introduced to ensure a specified reliability with variable renewable energy generation and consumer loads. Incentive‐based demand response is introduced to allow a reduction in customer loads, up to a maximum value, during peak load events. Customers receive a financial benefit as an incentive for the total demand response energy reduction. Active power operation of four different power system configurations is modelled over one year in hourly time steps. The study uses real data for customer demand, wind speed, solar insolation and ambient temperature profiles in a specific location. The hybrid power systems with demand response are optimised to minimise the system net present cost in project lifetime (20 years) using a particle swarm optimisation algorithm. Sensitivity analysis of levellised cost of energy for various values of the maximum demand response power and the incentive payments are also carried out.