The Reagan administration yesterday gave up efforts to ban urea-formaldehyde foam insulation, which has been linked to cancer in animals and a variety of health problems in humans.

The seven-year fight over the controversial plastic foam ended when the Justice Department decided not to appeal a Fifth Circuit Court of Appeals' ruling that overturned a Consumer Product Safety Commission ban on use of the product.

The decision by Solicitor General Rex E. Lee was seen as a significant setback for the CPSC, which voted Feb. 22, 1982, to impose the ban after studying and debating the problem since 1976.

"This is a blow for the agency--there's no other way to read it," said David Greenberg, legislative director for the Consumer Federation of America, a national consumer group active in health and safety issues.

CPSC Chairman Nancy Harvey Steorts, a Reagan appointee who normally has opposed mandatory government actions but who fought for the UF-foam insulation ban, immediately issued a warning that the urea-formaldehyde foam, commonly called UF-foam, still presents a risk for consumers.

She said the fact that the insulation "can once again be manufactured and installed in American homes should in no way lead consumers to the mistaken belief that this product is now considered safe." More than 2,200 complaints involving 5,700 persons and citing UF-foam as the cause of respiratory and other health problems have been received by the commission, Steorts said.

According to the Formaldehyde Institute, a trade group, no UF-foam insulation is being made today. "It is unlikely that the industry will ever bloom again, because obviously there is a decided fear on the part of the consumer," said Ed Stana, the Institute's public relations man.

An estimated 500,000 homes now have insulation made from UF-foam.

Formaldehyde manufacturers claimed at the time of the ban that the action wasn't justified by medical or scientific findings.

But extensive studies and tests by the CPSC suggested that formaldehyde gas released by the insulation caused some persons to experience eye, nose and throat irritation, respiratory distress, skin irritation and nausea, headaches and dizziness.

The CPSC voted 4 to 1 to ban the insulation, effective Aug. 10, 1982, but several lawsuits were filed challenging the order. The Fifth Circuit overturned the CPSC rule April 7, saying the commission had failed to produce the "substantial evidence necessary" to support the ban.

However, the ban remained in effect--pending possible appeals--until yesterday when Solicitor General Lee decided not to appeal the case to the Supreme Court.

Lee said his decision had nothing to do with the merits of the agency's ban and "little to do with whether we think we could win the case in the Supreme Court." Furthermore, he added, "it says nothing about my views on formaldehyde."

When deciding whether to appeal a case, Lee said he looks at several criteria, including whether the appellate court decision contained some new legal principle that is unsettled or at odds with established Supreme Court principles. The insulation ban didn't have any new legal principle, he said, so he decided not to appeal. Politics wasn't involved in the decision, Lee said.