Electrical – How much RAM do I have for dynamic memory allocation in the Nios II

It's not clear what you are really asking, but it is common to store binary values that are wider than the addressable unit of memory. For example, if you want to store 16 bit words in a byte-addressed memory, then you use two bytes. That also means the software has to know which byte is stored first.

In your case you seem to have native 4 bit words. To store a 16 bit value, use 4 words. Again, your software will have to know what convention you are using, like low word first or high word first.

Since your memory only has 4 address lines, its size is limited to 16 native words. Your native word size appears to be 4 bits, so your memory can hold only 64 bits. That means it will be completely used up by two 32 bit values or four 16 bit values, for example.

Note that 'MCU will stop running' versus 'MCU still running' is not a good criterium for 'everything is OK'.

On ARM chips. the stack grows down (starts high, each nested stack frame occupies lower addresses), in most cases starting from the highest RAM address. When the stack grows too large for the available stack space, it will overwrite the heap, and after that global data. Whether this is harmful for the program depends. On what? That's mighty complex to figure out.

Note that the 'data[999]' in your 'char data[1000]' is the highest address within this variable, so it is the least likely to cause a problem. using data[0] (which is at the lowest address) is more likely to cause a problem.

Again on ARM, a function that does not call deeper functions might not use the stack at all (the return address is saved in a register, not on the stack).

So in all probability, both your programs are bad, but whether in practice that translates to 'seems to work' or 'seems to stop' is very difficult to predict.