Pure In2O3 nanoparticles are prepared by a facile precipitation method and are further modified by Ag. The synthesized samples are characterized by scanning electron microscopy, transmission electron microscopy, energy dispersive X-ray spectroscopy, X-ray diffraction, Raman and UV-Vis spectra. The results show the successful heterojunction formation between Ag and In2O3. Gas sensing property measurements show that the 5 mol % Ag-modified In2O3 sensor has the response of 67 to 50 ppm ethanol, and fast response and recovery time of 22.3 and 11.7 s. The response is over one magnitude higher than that of pure In2O3, which can be attributed to the enhanced catalytic activity of Ag-modified In2O3 as compared with the pure one. The mechanism of the gas sensor can be explained by the spillover effect of Ag, which enhances the oxygen adsorption onto the surface of In2O3 and thus give rise to the higher activity and larger surface barrier height.