Philippe Coutinho's second goal of the season put Brendan Rodgers' side in front after 24 minutes in the battle of the Premier League's two most free-scoring sides at the Etihad Stadium.
Vincent Kompany equalised just seven minutes later and Simon Mignolet was at fault for Alvaro Negredo's 14th goal of the season that put City in front on the stroke of half-time.
The second half failed to live up to the scintillating first 45 minutes, but Liverpool had their chances to salvage at least a point and Raheem Sterling was guilty of a glaring miss.
City are now just a point behind leaders Arsenal in second place and have won six of their last seven top-flight games, while Liverpool sit three points behind Arsene Wenger's side in fourth.
Martin Demichelis (knock) was ruled out, so Joleon Lescott came into the heart of the City defence. Pablo Zabaleta returned from a hamstring injury and Jesus Navas started as Gael Clichy and Edin Dzeko dropped to the bench.
Liverpool were without full-back Jon Flanagan (hamstring), so Aly Cissokho got the nod to replace him.
City wasted no time in showing their intent and were almost in front after four minutes as Aleksandar Kolarov whipped in a cross and Navas stooped at the back post to head back across goal, but was denied by the outside of the post.
Liverpool soon got into their stride and were in front after 23 minutes when Sterling got on the end of Luis Suarez's exquisite flick then rounded Joe Hart and Coutinho nipped in front of the winger to slot into the empty net from a tight angle.
City were a constant threat and it took them only seven minutes to get back on level terms as Kompany rose to head down David Silva's corner and Joe Allen was unable to clear on the line.
Both sides were causing all sorts of problems going forward and Hart denied Coutinho a second goal after great link-up play by the lively Sterling and Suarez, before Martin Skrtel produced a vital last-ditch block to thwart Alvaro Negredo.
Negredo was not to be denied in first-half stoppage, though, as Mignolet could only palm the striker's left-foot strike behind him and into the net after Navas had picked out his Spain team-mate.
Liverpool started the second half on the front foot and Kolarov was almost made to pay for being far too casual in the area when Suarez robbed him, but the Uruguayan's shot hit Jordan Henderson and the defender's blushes were spared.
Negredo rose to meet a Silva corner but headed straight at Mignolet. Liverpool continued to ask questions of the City defence and Glen Johnson's touch let him down after Lescott's attempted clearance fell nicely for him.
Henderson forced a save out of Hart with a cheeky backheel and then Sterling spurned a golden opportunity after 72 minutes when he inexplicably fired over the bar from close range.
Suarez blasted a free-kick over the crossbar from long range, but there was no way back for Liverpool.
