Electricity generation accounts for nearly half of the total CO2 emissions in the United States. For this reason, the development and integration of renewable resources will play an essential role in achieving the societal objective of mitigating climate change through reduction of greenhouse gas emissions. In conjunction with the environmental benefits of renewable energy, the most common renewable sources, such as wind and solar, also increase the uncertainties surrounding generation in power systems, which adds significant challenges to the system operation and planning. The uncertainties and forecasting errors surrounding renewable generation are normally addressed through the use of reserves from traditional generators. At greater levels of renewable penetration, sufficient generator reserves may not be available or economically viable. In contrast, the promise of demand-side resources in this arena lies in the spatially widespread availability, rapid response potential, and lower cost of features that already exist in the system. However, the challenge of responsive demand arises from the need to understand, manage, and incentivize a very large number of resources to participate effectively in efficient operation of the complex power system. Since demand response comes from the distribution system, microgrids as the basic building blocks of future distribution systems will be a critical environment for the study of demand response. To support integration of microgrids with flexible loads in future power systems, the operational mode of power systems will need to evolve. Therefore, it is going to be critical to have new and efficient co-optimization methods for coordination of the various power market participants and the scheduling of resources in the power systems of the future. Motivated by the rapid increase in renewable penetration, the need for effective demand response programs, and a changing system structure, this dissertation seeks to define a new strategy that supports co-optimization of various participants in power systems with emphasis on high renewable penetration and demand response. This strategy has three components; 1) an exploration of the capabilities of different types of demand response programs in a microgrid, 2) development and implementation of a bi-level framework for co-optimization of the main grid with high renewable penetration and a microgrid with demand response capabilities, and 3) expansion of the bi-level framework from a microgrid to a general distribution system to explore the advantages of the bi-level co-optimization approach over the traditional optimization approach. Conclusions of this work illustrate that the stochastic rolling horizon approach could effectively manage the operation of a microgrid with various demand response programs. In addition, the bi-level approach is a promising co-optimization framework for the transmission and distribution levels that could increase system renewable penetration and reduce operation costs. Compared to the traditional framework, the bi-level framework yields more equitable cost sharing patterns among the market participants as well as better support for the power system evolution.