The Federal Energy Regulatory Commission (FERC) recently attempted to standardise how demand reponse of retail consumers should be compensated in U.S. markets [1].
In response, 30 economists wrote a protest note [2]. The main criticism is about the recommendation that the compensation for demand response (for energy not used) should be the full market price (in this case the Locational Marginal Price (LMP)). The economists argue that the consumer should still pay the retail price (so, in effect, be compensated with LMP minus the retail price) and I fully agree. In fact, I used a similar setting in a recent publication [3] where I propose a novel market mechanism for procuring demand response capacity.

The protest note says: "Like other call options, the amount the demand-response provider receives must be offset by the strike price (here, the retail rate). Failing to subtract the retail rate, by contrast, allows the consumer to sell its electricity at full rates without ever having bought it."

This sounds simple enough if you think about it, but the FERC argues that "the Commission is not limited to textbook economic analysis of the markets subject to our jurisdiction, but also may account for the practical realities of how those markets operate." In fact, they mainly think of their measure as a subsidy to increase the ratio of flexible demand resources: "Removing barriers to demand response will lead to increased levels of investment in and thereby participation of demand response resources (and help limit potential generator market power)."

However, if they do get the incentives wrong, market failure is a very probable outcome.

[1] http://www.ferc.gov/EventCalendar/Files/20110315105757-RM10-17-000.pdf
[2] www.hks.harvard.edu/fs/whogan/Economists%20amicus%20brief_061312.pdf
[3] Nicolas Höning, Han La Poutré: Flexible Consumers Reserving Electricity and Offering Profitable Downward Regulation, In: Third IEEE PES Conference On Innovative Smart Grid Technologies (to be published December 2012)