BAGHDAD - Saadi Abdul-Rahman was recently forced to pull his three children out of school in the Iraqi city of Mosul, where Islamic State militants have ruled with an iron fist since June. The cost of living has soared there, and the family is barely able to make ends meet, even after putting the kids to work.

"We are not able to pay for cooking gas, kerosene and food," laments the 56-year-old retired government worker. "The situation in Mosul is miserable."

The economy in the self-styled "caliphate" declared by the Islamic State group bridging Iraq and Syria is starting to show signs of strain. Prices of most staples have more than doubled as coalition airstrikes make it difficult for products to move in and out of militant strongholds, leading to shortages, price-gouging and the creation of black markets.

Initial support

Resentment has grown among residents under the rule of the extremists, who initially won support with their ability to deliver services.

In the early days of its rule, the Islamic State subsidized food and gas prices through the wealth it accumulated from oil smuggling, extortion and ransom demands. The militants sold their smuggled oil at a discount - $25 to $60 a barrel for oil that normally cost $100 a barrel or more, according to analysts and government officials.

But in recent weeks, prices have soared in militant-held cities. Items like kerosene, used for heating and cooking, are in short supply, while others, such as alcohol and cigarettes, strictly banned by the group, are making a comeback at higher prices on the black market.

Black-market sales

Smoking is a punishable offense in militant-held Mosul. But at a warehouse on the outskirts of the city, cigarettes, as well as hard-to-come-by essentials like kerosene, can be found at hugely inflated prices on a black market run by the extremists. There, a pack of cigarettes sells for 30,000 dinars - the equivalent of $26 - more than double the pre-caliphate price, according to residents who spoke on condition of anonymity for fear of reprisals.

The militants "are developing an unsustainable economy," said Paul Sullivan, an expert on Middle East economies at the National Defense University in Washington. "Eventually the costs of keeping the subsidies and price controls going will overpower their smuggling funds, which are also used for offensive and defensive actions."

Unbalanced system

"They can collect taxes, extort money, and so forth," he said. "But that will likely not be enough in the long run to keep such an unbalanced economic system going."

In the Syrian city of Raqqa, the extremists' so-called capital, the breakdown of security along the border with Iraq in areas under Islamic State control has led to flourishing trade with Mosul. Trucks are also able to access the city from Turkey, allowing for a steady supply of fruit and vegetables, wheat and textiles. However, the cost of living has surged since U.S.-led airstrikes began in September, and power and water cuts grew more frequent, residents said.

In addition, the strict social laws imposed by the group have been very bad for business, said Bari Abdelatif, an activist in the Islamic State-controlled town of al-Bab in Syria's northern Aleppo province. But, he said, foreign fighters were bringing with them lots of hard currency, making up somewhat for the shortfall.

Last month, Abu Bakr al-Baghdadi, the leader of the Islamic State, decreed the minting of gold, silver and copper coins for the militants' own currency - the Islamic dinar - to "change the tyrannical monetary system" modeled on Western economies. But trade in most militant-held cities continues to be in Iraqi dinars and U.S. dollars.

The start of winter has led to serious shortages of gasoline and kerosene. The official price for a liter of gas in government-controlled areas of Iraq is 450 dinars [40 cents] - but in Mosul, it sells for four times that. Two-hundred-liter barrels of kerosene are now sold in Mosul for 250,000 dinars [$220], vs. the official price of 30,000 dinars.

In the western Iraqi city of Fallujah, under militant control for almost a year, residents have started cutting trees for firewood because kerosene is in such short supply. The city is surrounded by government troops, and near-daily shelling often makes parts of town too dangerous to visit.

Food and fuel prices have soared as a result.