How should I proceed knowing that the DLA pricing is higher than the initial quote? Shouldn't the Government be getting a lower price or discount?
The government does not always get a discount, and in some cases may actually pay more depending on other terms (warranty, delivery, etc.) that may be bundled with the price. In any case, because the vendor is not fulfilling the terms of the original quote, the government can award to another vendor if in fact another vendor offered at a lower price than this vendor's "DLA price."
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Because you will be cancelling the purchase order, you may want to consult with your organization's legal counsel for his/her opinion.