Mustafa Barghouti, runner-up in last January's presidential election, and the former peace negotiator Hanan Ashrawi were both trying to defy a ban on any election activity in the eastern half of the city, which was occupied and then annexed by Israel after the 1967 Six-Day War.
Mr Barghouti was arrested while on a walkabout in the Arab quarter of the walled Old City while Ms Ashrawi, who is a resident of East Jerusalem, was ordered to stop canvassing in the same area.
Palestinian leader Mahmoud Abbas has already said he will cancel the election scheduled for January 25 unless residents of East Jerusalem can join the democratic process, a threat repeated by Palestinian Prime Minister Ahmed Qurie.
The Islamist movement Hamas however warned against any such move, denying there was any agreement with Mr Abbas's Fatah faction for a postponement without voting in East Jerusalem.
Presence illegal
Mr Barghouti said after his release that he had had been told his presence in Jerusalem was illegal as he had no permit to enter from the West Bank.
"The risk of arrest will not prevent me from returning to the city in which I was born," he told reporters at the Qalandiya checkpoint between the West Bank and Jerusalem.
He said that his arrest was "further evidence of Israel's long-term efforts to undermine the democratic process in Palestine."
Ms Ashrawi escaped being detained but only after police had forced her to stop displaying a banner for the Third Way, a line-up of independent candidates which also includes the outgoing finance minister Salam Fayad.
"All we did was explain our platform to the Palestinians in East Jerusalem," said Ms Ashrawi.
"It is our right to explain our platform to our constituents. There is no reason to intervene forcibly and take down our banners."
Shortly before police intervened, Ms Ashrawi had told reporters that she had decided to launch her campaign in Jerusalem "because it is the capital of Palestine and an occupied city".
Reacting to the arrests, Mr Qurie reiterated his assertion that "the elections will not take place without Jerusalem".
"Jerusalem is an occupied city and all the candidates should be able to campaign there freely," he said.
"They (Israel) should not only allow the people of Jerusalem to cast their ballots but also authorise candidates to campaign unhindered," added the premier who is not standing for re-election.
In an interview, Mr Abbas said that "if (East Jerusalem) is not included, (Palestinian) factions are unanimous that there will be no election."
Hamas candidates
Ismail Haniya, who heads the list of Hamas candidates, however denied there was any such agreement.
"We do not believe that postponing the election should be the solution," Mr Haniya said at Hamas's campaign launch in Gaza.
The participation of Hamas, responsible for the majority of anti-Israeli attacks in the past five years, was one of the reasons cited by Israel when it initially announced it would not allow voting in east Jerusalem.
Residents had been allowed to cast their ballots at post offices in the last parliamentary election a decade ago as well as in the January presidential election.
Senior Israeli foreign ministry official Gideon Meir said that a final decision on East Jerusalem was still awaited.
"Discussions are ongoing but no decision has been made yet," Mr Meir said.
"However, we can say categorically that a terrorist organisation such as Hamas should not take part in the elections as it calls for the elimination of the state of Israel and orders the murder of our nationals."