Gas-sensing properties of oxide semiconductors improves by using then in nanocrystalline forms. The sensitivity of gas-sensor has also been modified by adding metals or metal oxides as catalytic agents. Using the In2O3 and Ag nanoparticles as the precursor; In2O3: Ag composite nanoparticle layers have been grown. It has been demonstrated that a decreasing particle size leads to an increased sensitivity and a decreased response time. At C2H5OH concentration of 1000 ppm in air and at an operating temperature of 400°C, sensitivity and response time of 325 and 8 s, respectively have been achieved in case of In2O3 nanoparticles with a size of 14 nm. With the addition of 15% silver, response time of 6 s and sensitivity of 436 has been obtained for 1000 ppm ethanol at 400°C. Ag2O nanoparticle draws electrons from the In2O3 layer and enhances the formation of electron-depleted layer. On exposure to a reducing gas, interfacial Ag2O is reduced to Ag, with a decrease or disappearance of the space-charge layer. Gas sensing response thus depends on the change in depletion layer in interface from Ag2O-In2O3 to accumulation layer in Ag-In2O3.