Birmingham battled back after they had central defender Martin Taylor sent off in only the second minute for a dreadful tackle on Eduardo, who suffered a broken leg.
Arsenal were expected to swamp ten-man Birmingham, but that didn't materialise as McFadden gave Birmingham a surprise 28th minute lead with a goal direct from a free-kick.
But in the second half Arsenal took control with young Theo Walcott seemingly putting the league leaders into a winning position with two smartly taken goals.
Birmingham, however, never gave up hope and in the last minute Stuart Parnaby, who had taken over from Mikael Forssell to boost Birmingham's defence, won a penalty when he was brought down by Gael Clichy.
McFadden, who was always a thorn in Arsenal's side, grabbed the ball to convert his spot-kick to record his third goal in two games for Birmingham since his move from Everton.
The surprising feature of the game was Arsenal's inability to overcome Birmingham. Two games in the previous five days appeared to have taken its toll and they could not capitalise upon their man advantage.
In the first half they appeared to have been upset by Eduardo's tragic injury.
Birmingham battled bravely against considerable odds and in the 28th minute turned the game upside down when McFadden put them ahead.
The tenacious Scot was always troublesome and Arsenal had great trouble when he had possession. The frustration resulted in Mathieu Flamini conceding a free-kick on the edge of the area.
McFadden, almost casually, glided in his left-footed free-kick into the top corner of the net out of the reach of Manuel Almunia.
Arsenal had most of the play but it was McFadden who had the best chance of adding to his tally, when he broke clear from near the halfway line only to shoot wide as he was challenged by Philippe Senderos.
Four minutes into the second half a Fabregas corner was knocked down for Walcott to obtain his first Premier League goal for the Gunners.
The former Southampton player then snapped up a mistake by Ridgewell and fired home his second goal in the 55th minute.
Arsenal were seemingly home and dry but then decided to make two substitutions four minutes from time. This disrupted the side and in the last minute Parnaby won the penalty which enabled McFadden to score and give Birmingham their second draw of the season against Arsenal.