Source music refers to music in a drama (e.g., film or video game) that is part of the fictional setting and so, presumably, is heard by the characters. It can be background music (e.g., from a radio or TV) or be produced by characters themselves as part of the plot.
The opposite of source music is underscoring, which is music heard by the viewer (or player), intended to comment on or highlight the action, but is not to be understood as part of the "reality" of the fictional setting.
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