Harry Wilson’s 13th goal of the season - a penalty he won and converted - gave Neil Critchley’s team an early lead at the Etihad Campus, but the hosts struck back twice before the break through Lorenzo Gonzalez and Rabbi Matondo.
Then, during a lengthy period of first-half stoppage time following an injury to City’s Benjamin Garre, Liverpool striker Rhian Brewster landed awkwardly while challenging for a header and had to be stretchered from the pitch.
The young Reds responded to that setback admirably at the start of the second half, with 16-year-old debutant Curtis Jones impressing and Wilson going close to an equaliser shortly after the restart.
But their endeavours to force a leveller were undone by a clinical half-volley from City’s Felix Nmecha 15 minutes from time.
Toni Gomes diverted home Liam Millar’s cross in the last minute to set up a tense finale, but City held on.
Despite their second successive PL2 loss, Liverpool remain top of the division, sitting one point clear of Leicester City with a game in hand.
After a slow start, an injection of quality from Wilson resulted in the opening goal in the 14th minute.
A wonderful first touch from Liverpool’s captain enabled him to surge past Joel Latibeaudiere, with the City defender’s desperate lunge then felling the Welshman.
The referee duly pointed to the spot and Wilson picked himself up to send Curtis Anderson the wrong way from 12 yards.
An unmarked Wilson then glanced a header wide from Yan Dhanda’s whipped cross as the young Reds immediately went in search of a second.
However, City were back on level terms by the 20-minute mark when Gonzalez took full advantage of some lax defending to race clear and slot beyond Kamil Grabara.
And, shortly before half-time, the hosts went ahead.
With Mich’el Parker struggling with an injury, Matondo breezed past the Liverpool right-back and finished well following a direct, driving run from deep.
City’s second goal sparked a flurry of incidents.
First, Grabara denied Matondo before Brewster struck the post after collecting a deft pass from Jones, who replaced Parker, in what was the striker’s final contribution prior to his unfortunate injury.
Despite the blow of losing two players in quick succession, Critchley’s side began the second period strongly and Wilson could have restored parity when he latched on to Millar’s flick and poked wide.
Bobby Adekanye sent a wayward shot high and wide after Jones had set him up and Anderson held Wilson’s curling free-kick as Liverpool turned the screw.
City, though, soaked up the pressure well and Nmecha’s strike proved crucial as it rendered Gomes’ well-taken volley in the 90th minute a mere consolation.
Liverpool U23s: Grabara, Parker (Jones), Masterson, Johnston, Juanma, Kane, Alves, Wilson, Dhanda (Gomes), Adekanye, Brewster (Millar).
Unused sub: Kelleher.