Final answer:
The statement is true because in the IS-LM model, a tax cut increases income and shifts the IS curve right, but also raises interest rates, which can depress investment and lead to a smaller increase in income than what is predicted by the Keynesian Cross model.
Step-by-step explanation:
The increase in income due to the tax cut is indeed smaller in the IS-LM model than in the Keynesian Cross because the higher interest rate depresses investment which is correct, making the answer A.True. In the Keynesian Cross model, the focus is mainly on the goods market, and an increase in income leads directly to a rise in consumption and aggregate demand. However, the IS-LM model introduces the money market into the analysis.
In the IS-LM framework, a tax cut increases disposable income and therefore consumption, shifting the IS curve to the right. This raises the equilibrium level of income but also leads to an increase in the interest rate due to the interaction with the LM curve, which represents the demand and supply for money. As interest rates rise, investment may fall because the cost of borrowing increases. This feedback loop from higher interest rates to lower investment is what makes the IS-LM model predict a smaller increase in income in response to a tax cut compared to the Keynesian Cross model.