A potentially explosive showdown between the Israeli police and a group of Jerusalem slum dwellers demanding lowcost housing today threatened to further weaken the government of Prime Minister Menachem Begin and trigger additional demonstrations across the country.

For a week, the protesters have been camped on public land in southern Jerusalem, and have emulated the tactics of the ultranationalist settlement movement, Gush Emunim. The protesters have declared themselves a vanguard building a new city called "Ohel Moreh." The name is a play on Elon Moreh, the controversial Gush Emunim settlement in the occupied West Bank, and means "tent of the teacher," a biblical reference to the wanderings of the patriarch Abraham.

At first, the squatters presented little more than an embarrassment to Begin in their efforts to draw attention to the fact that Israel, despite a worsening economic situation and inadequate funds for social programs, is pouring millions of dollars into Jewish civilian settlements in the West Bank and Gaza Strip.

But as the 40 young families dug in and seriously began working on the new urban settlement, the government found itself in a quandary: it can either forcibly evict the squatters and infuriate poor people throughout Israel, or it can surrender to the demands and promise new housing at a time when every government agency is facing sweeping budget cuts.

A confrontation is expected Monday -- the deadline imposed by the government for a negotiated agreement or forcible eviction. The police have been ready since Thursday to remove the settlers, but have held off under pressure from the government.

The squatters said today that hundreds of young men from Jerusalem's slums have vowed to help them resist if the police move in. They also have said they will not leave until they obtain a promise that the government will build subsidized housing on the site.

Located on a winding road in the Judean Hills on the outskirts of the city, Ohel Moreh looks more like a tourist camping site than the start of a settlement. Colorful orange-and-blue tents encircle a larger tent that serves as communal dining hall and meeting place, and the beginnings of permanent structures are evident. Police, however, have stopped work on concrete block showers and other structures.

Backed by Ohel, a self-help organization working in the city's slums, the settlers have organized an urban collective, drawing volunteers from such trades as plumbing, electrical contracting, carpentry and masonry.

"We have decided to act in the only way effective in Israel -- the way of Gush Emunim -- courage, chutzpa, ignoring certain norms, faith in one's goals and settlements," the squatters declared on the day they broke ground for the settlement.

Begin chastized the group's leader, Yamin Suissa, at a meeting Friday, telling him, "The law is the law." But Suissa responded, "I learned from the Gush Emunim that the law is not important."

With about 100 children under the age of 7, the squatters moved into the tent city at 3 a.m. June 8. They had their tents erected by daybeak -- just as Gush Emunim settlers have done when they establish illegal settlements in the West Bank.

A spokesman for Ohel, whose members are Sephardim -- Jews of Mediteranean origins -- residing in southern Jerusalem's slum districts, said nearly 30 other tent cities will be established in other cities in Israel.

As they sweltered in their tents under a relentless sun and nearly 100-degree heat, Ohel Moreh residents said all they are seeking is government help in building their own low-cost housing.

Moti Nagar, 32, and father of three, said he received a government-subsidized mortgage in 1973. But when he returned from the Yom Kippur War later that year, he lost his business and could not meet his mortgage payments.

"I never voted in any election, and I don't care about politics. I don't care where the money comes from, "Nagar said. "I just want a place to live and raise my family."

Ronnie Eluz, 25, who has lived with his wife and two children in two rooms with an outdoor toilet, said, "We want the government to recognize that we are no longer little punks making trouble. We are family people who want to raise our children in conditions better than we [had] . . . Why should I leave Jerusalem? I love Jerusalem."

All of the squatters interviewed said they are demanding only what the Begin government has willingly given the Gush Emunim.

"We want the same conditions. Give us land and some loans and we can build our own houses," said Aliza Asayag, who had been living a tenement with her two children for $65 a month.

Discord, however, has surfaced in Ohel Moreh over financial assistance given to the squatters by a member of the Israeli's parliament, Shumuel Flatto Sharon. Flatto-Sharon is a flamboyant millionaire who has been under investigation in France for income tax evasion and in Israel for election irregularities.

The involvement of Flatto-Sharon, who has financed about $43,000 of the cost of putting up the tent city, has caused some social activists to worry that Ohel may have sold its independence to political interests and helped the parliament member create a new constituency with his money.

Ohel previously had received financial backing from Geneva-based millionaire Nessim Gaon, who is presdent of the World Sephardi Federation, but who has recently sought to develop more of a grass roots image in Israel.

Gaon, who is here as a mediator in the dispute, today urged the squatters to withdraw peacefully.