Ms Royal, the mother of Mr Hollande's four children, heads a ministry in charge of ecology, sustainable development and energy.
She is a senior figure in the Socialist Party and was its presidential candidate in 2007.
It was reported in France that Mr Hollande's most recent official partner, Valerie Trierweiler, had opposed Ms Royal's appointment to any position in the government. Mr Hollande and Ms Trierweiler officially split up in January after a magazine claimed he had been having an affair with an actress.
Pictured between Mr Hollande and Ms Royal yesterday was the new prime minister Manuel Valls.
The cabinet reshuffle was prompted by big losses for the Socialists in municipal elections last weekend.
Fixing the ailing French economy will be the new government's top priority, and major spending cuts are expected.
Mr Valls will set out the new government's policy plans in an address to parliament on Tuesday, when the newly-formed government will seek a confidence vote.
The original plan had been to tie the vote of confidence to a subsequent vote on President Francois Hollande's pro-business "responsibility pact" offering payroll tax cuts to companies - a key reform opposed by some on the left.
The green light from parliament would allow the reform to be implemented without being subject to a separate vote in parliament.