Goalkeeper David James earned Liverpool's badge of honour to help embattled manager Graeme Souness celebrate his team's first win in eight matches.
James superbly saved a penalty from Arsenal dangerman Paul Merson two minutes after John Barnes had confidently fired home a spot-kick at the other end.
Arsenal, who had left-back Nigel Winterburn sent-off three minutes from time for his second bookable offence - a foul on winger Steve McManaman - suffered their tenth Premier League defeat of the season, virtually wiping out their remote chance of a championship challenge.
Liverpool needed 6ft 4in James' heroics in the 61st minute after Mark Wright tripped Kevin Campbell and the giant goalkeeper's spectacular, full-stretch save from Merson's hard-hit shot was enough to end Arsenal's six-match unbeaten run.
Ian Rush struck a post with a chance to make it 2-0 16 minutes from time but injury-hit Arsenal could not make capital from this escape and were left to rue their fourth spot-kick failure of the season.
Barnes showed them the way to do it in the 59th minute. Arsenal goalkeeper David Seaman bravely blocked the ball at the feet of Rush but, as the Welshman tried to snap on to the loose ball, he was pulled down by Andy Linighan.
Barnes then sent Seaman the wrong way from the 12-yard mark.
The spasmodic moments of drama came in a frenetic second half that finally produced some action following a grim opening 45 minutes.
There was so much tension and tight marking that neither side could find the space for creative construction but Liverpool showed the commitment that Souness demanded.
Paul Stewart's second minute lunge on David Hillier led to the Arsenal player limping off ten minutes later with a thigh injury after Stewart fouled him again, earning a yellow card from referee Keith Cooper.
Former Tottenham player Stewart was cat-called throughout by the angry Arsenal fans but Winterburn's 27th minute tackle on McManaman was almost as reckless and also deserved the booking.
James, a one million pound buy from Watford last summer, stood up well to stop fierce drives by Campbell in the first half and, having only recently regained the first team spot from Mike Hooper, dealt commendably with a barrage of high crosses.
The luckless Alan Smith twice flicked goal-worthy efforts just off target and Campbell gnawed continually at the Liverpool back line.
But the Merseysiders kept their discipline and spirit, with the pace of Barnes and Rush troubling Arsenal in the second half which finally payed off with the Liverpool decider.
Souness saw his Liverpool side snatch victory at Highbury for their first win in eight games and said: "What delighted me most was our defending. We've got a young goalkeeper here who we believe is going to be one of the best in the country and today he did everything right. But what delighted me most was how well we defended because that is something we haven't been doing. I still maintain I have got the most talented group of players in the country but that's no good if too many of them are sitting in the stand with long-term injuries. If I can keep this back four together for a few matches we've got the chance to go on from this result."
Modest hero James said: "It is part of my job to save a penalty but I'm happy because it's the first clean sheet I have had in the league for Liverpool."
Barnes said: "I've taken quite a few penalties against Arsenal's David Seaman and I was surprised he dived the wrong way for this one. But hopefully this is a springboard for us towards better results."
Seaman claimed that the Liverpool penalty, resulting from Andy Linighan's foul on Ian Rush should not have been given. He said: "I had the ball at Rush's feet but he kicked through my hands and it bounced away."
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