Sound whose source is visible on the screen or whose source is implied to be present by the action of the film:
Digetic sound can be either on screen or off screen depending on whatever its source is within the frame or outside the frame.
Another term for diegetic sound is actual sound
The film's diegesis is the total world of the story action
Sound whose source is neither visible on the screen nor has been implied to be present in the action:
The distinction between diegetic or non-diegetic sound depends on our understanding of the conventions of film viewing and listening. We know of that certain sounds are represented as coming from the story world, while others are represented as coming from outside the space of the story events. A play with diegetic and non-diegetic conventions can be used to create ambiguity (horror), or to surprise the audience (comedy).
Another term for non-diegetic sound is commentary sound.
Bordwell-Thompsson, Film Art
Reize-Millar, The technique of filmediting
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