This paper presents a two-stage optimization technique in sizing various components of standalone hybrid electricity systems with time-of-use (ToU) incentive demand response program. In the first stage of optimization, the minimum levelized cost of electricity (LCOE) is determined without using demand response. The result of the first stage (LCOE) is used as a base rate to develop a ToU demand response for incentive payment in the second stage of optimization. In developing the incentive payment, three periods of a day (off-peak, shoulder, and peak) with different payment rates of electricity are considered. Five different standalone system configurations are developed using various combinations of diesel generators, wind generators, solar photovoltaics, battery energy storages, and flywheels. The proposed two-stage optimization technique is then applied to all five configurations of a remote area South Australian community. Real yearly data of electricity consumption, solar radiation, wind speed, and air temperature, as well as real market price of the components are used in the optimization. It has been found that the hybrid standalone system consisting of diesel, solar, wind, and battery has the minimum overall cost of electricity.