Animation is more costly, time consuming and still returns a mediocre result in this sort of context. I think that was a difficulty for the writers - the fact that they were bound to the animated sequences they'd written that were in production while trying to improv and keep things fresh with the puppets. It took away some of the spontaneity, but I think they could have written around that.
Yes and no. Animation does take a long time, and it is expensive, but considering how expensive it is to make a Muppet, for various animated sequences that require large crowds of oddly designed characters- not to mention building of props and sets, it somehow shifts to the animation category being cheaper... especially with the use of non-union overseas animation firms (Why, the Japanese animators finally got a union last year).
I really think certain things could have worked with live action, the Pigs in Space and Kermit PI bits especially... but then, why not just make a special saturday morning version of the Muppet show for younger audiences? Without guests?
The thing is, I do agree that the puppets and cartoon segments are an odd mix, and I feel they did much better with Dog City (with the exception of recent projects, I've always been a fan of the Canadian firm, Nelvana). But then of course, the point of the show was a puppet animator animates a cartoon version of (what is basically) himself.
I admit that Toei's animation for LMM wasn't great, but it's still much better than late season muppet babies done by a Korean (or was it Taiwanese?) firm that did a truely sloppy job.
I do like the animated Backgrounds, though. Very Muppet kid's book style.