A budget hotel, convenient to the start of Oxford St (the place to be for Mardi Gras):

http://www.yhotel.com.au/

A more upmarket hotel, in a similar location:

http://www.oakshotelsresorts.com/oaks-hyde-park-plaza/

I don't have experience of either, but I know the locations quite well and have eaten in the restaurant at the Hyde Park Plaza. That hotel would probably be my preference.

Lavandula

A friend got a good deal on the Vibe in Haymarket recently, that's well located in terms of the start of the parade.

http://www.vibehotels.com.au/default.asp?page=/vibe-locations/sydney-hotels/vibe-hotel-sydney

Most of the gay pubs and night clubs are in Darlinghurst and Newtown.

Sunrise Lodge is good value in Newtown http://www.australiansunriselodge.com/

In Darlinghurst/Paddington the Art Hotel is usually very well priced. It's a couple of blocks back from the main part of Oxford st nightlife.

http://www.artshotel.com.au/

I have used wotif.com for discounted hotel prices in Sydney in the past. Prices look pretty steep for Mardi Gras week, but it still might be worth a look. Also check out hotel.com for discount prices.

About a block from the Y Hotel, recommended above, is the Travelodge on Wentworth, which I have stayed at. It's not fancy, but the rooms are fairly large, it has an in-room kitchenette with microwave, ensuite facilities, and laundry facilities are available. It is only about a five-minute walk to Oxford St. (The cheapest rooms at the Y Hotel have shared bathrooms).

Have you considered switching hotels during your stay? A bit inconvenient, but I have done it when I have been in a city during a special event. I travel light, and as long as the hotels are in the same general area, it isn't a big deal. It might be worth it to get reasonably-priced rooms for your stay.

I have also stayed at one hotel, but booked it through two different websites, i.e., one website only had availability for certain days, but when I went to a different discount website I was able to book the other days.

Good Luck!

Don't know your budget but Simpsons of Potts Point is a small heritage property (owned by friends) who are very gay friendly. In a great spot but a little away from Oxford Street but I think that is an advantage these days .

If looking on wotif or last minute etc look around the Surry Hills area .