In this paper, we extend the standard Pissarides model of equilibrium unemployment to incorporate public-sector employment. We modify the Pissarides model in three ways. First, we assume that workers are heterogeneous in terms of human capital. Second, we assume that productivity is match specific and that the distribution of match-specific productivity is more favorable in the sense of first-order stochastic dominance the higher is a worker's human capital. Third, we allow for both private- and public-sector employment. In this preliminary version of the paper, we lay out the model and prove the existence of equilibrium. In the next version of the paper, we will numerically analyze the effects of public-sector employment
policy on the distributions of wages, productivities and human capital levels in the two sectors and on overall employment and welfare.