The Gunners are keen to land a world class striker this summer, and had looked set to land Argentine hitman Higuain in a club record deal.
But despite previously agreeing terms on a £27million switch, Madrid are now demanding £40million for the 25-year-old, with Napoli now also in the running for his signature.
The news has infuriated Arsene Wenger, with reports in Spain now suggesting he is ready to pull the plug on the deal and focus on Liverpool ace Suarez.
Arsenal have already had one bid of around £25million knocked back by the Reds, but are now expected to return with a fresh offer within days.
Wenger is believed to be willing to spend extra to bring in Suarez, who has told Liverpool he would be interested in a switch to the Emirates, but has so far refused to hand in a formal transfer request.
Suarez has already been told he has until the end of the month to sort out his future, but Liverpool are still hopeful he will remain at the club for at least another 12 months.
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