Refer to this Demand Response article to learn more about how demand response works.
Similar to how HOMER Grid calculates the demand limit with demand charges, it creates a separate demand limit for each Demand Response event. It then performs a 2 D optimization with the Demand Limit for demand charges and the Demand Limit for a Demand Response event. This optimization will attempt to reduce the overall costs.
If there are multiple Demand Response events in single month, then the optimization proceeds in a chronological order. Each optimization would include the Demand Limit for the monthly demand charges and the Demand Limit for the current Demand Response event. Once it finds the optimal value for this 2 D optimization, it moves to the next Demand Response event.
Note: If you specify a bid limit (either reduce by or reduce to), HOMER Grid does not optimize. If it is unable to meet your bid then the simulation is declared infeasible.
How does HOMER consider the trade off of DCR versus DR incentive
While HOMER Grid dispatch performs it's iterative numerical optimization, it tests a wide range of combinations to find the optimal costs. It looks at the trade off in savings from reducing demand charges versus savings from minimizing grid purchases during a demand response event.
Let us consider an example where the monthly demand charge is 30$/kW and the demand response incentive is 30 $ for every kW reduced. Let us assume there are 5 Demand Response events in the month. If we reduced the monthly peak demand by 100 kW throughout the month, then the total savings by demand charge reduction is = 30 * 100 = 3000 $. However, if we reduced 100 kW during each of the 5 Demand Response events, then the total savings by demand response is = 30 * 100 * 5 = 15000$