It's easier to just have each user store their private information in encrypted disk images since the old Filevault (1) method of encrypting the entire home folder isn't something you can set up on Lion with easy tools.
Lion does still support it, so you could migrate in a shell system that had the necessary accounts set up to use file vault, then encrypt the drive and finally move in the files from a backup external drive and presumably have both the legacy filevault storage scheme as well as the new scheme where the entire disk is unavailable until the drive password is entered.
Keep in mind - root (and any admin user that knows sudo) has total control of the system and can delete, remove any protection that was set by root. Using encryption with a distinct password is the only method to prevent root from actually making sense of the files it can easily access.
Filevault's use the XTS-AES 128 encryption. As Finder's contextual menu encryptation option and the Erase with the Encrypted format use Filevault's system, the encryption is the same.
Disk Utility's, in the other hand, when creating an new image, lets you choose between a 128 or 256 bits AES Encryption.
These two methods are, therefore, different. The latter just creates a folder which requires a password to be opened, while Filevault is a lot more complex.
And for the Logical Partition, here is explained in detail.
How Does FileVault 2 Work?
Compared to the bare file system, or even FileVault 1, FileVault 2 seems like magic. How does it work? The first thing to know is that Apple has included a Logical Volume Manager (LVM) with OS X Lion. This is what FileVault 2 gets to ride on top of. 
Physical media still exists—we really can’t get away from that, as the data need to be stored somewhere. CoreStorage doesn’t really care what the media is, though: traditional spinning-plater drives, SSD, USB storage or even a disk image. Represented above in green, we have three volumes that reside on some physical disks. These three volumes are converted into CoreStorage volumes and imported into a Logical Volume Group (LVG). This sets up a “pool” of storage. Volumes can be added to and removed from the pool after creation. A LVG is represented with a UUID. This LVG is then brought into a Logical Volume Family (LVF). An LVF maintains properties about the volumes in a LVG and presents these Logical Volumes (LV) to the system. CoreStorage creates new device nodes for each LV. As shown in the visualization above, the LVs, in blue, have a device node (disk1, disk2, disk3). The ‘key’ icon associated with the LVF shows that encryption is one of the properties maintained about the LVG. This is the layer at which the encryption key resides.
When you “Turn On FileVault…”, one of the steps converts your disk to a CoreStorage volume. Of course, when you “Turn On FileVault…”, only your boot disk is encrypted. Naturally, this fits Apple’s 99% case and is the right fit for the bulk of Mac users on the planet. That said, FileVault cannot and will not encrypt any other drives you may have attached to your system. That’s up to you.
Best Answer
Yes, you can do this using the built-in Disk Images of Mac OS X. A disk image (or DMG file) is a file which, when opened, presents itself as a removable Mac OS X volume, similar to a removable hard drive. Many OS X applications are deployed on disk images. If you encrypt your home directory using FileVault, you're creating a spare bundle disk image.
You can create OS X disk images which are compressed and/or encrypted. However, if you create a compressed DMG, it will be read-only, so that may or may not work for you.
To create a new, empty encrypted disk image in OS X:
Open Disk Utility, which is under the "utilities" folder of the "Applications" folder.
From the File menu choose New > Blank Disk Image...
In the dialog that appears, you can specify where to save the disk image, the name of the volume, and choose the type of encryption:
Make sure to choose either "128-bit AES encryption (recommended)" or "256-bit AES encryption (more secure)" from the "Encryption" menu. Also, be sure to set a size for the disk image.
If you create a sparse bundle (newer, and may be more reliable) or a spare image (older, can become corrupted easily if it's open and your computer is shut down improperly) then the image file will start small and will grow as you add files to it, up to a maximum size you specify.
If you create a "read/write disk image", then the image file will start at the maximum size specified in the dialog box.
After you save the disk image file, you'll be prompted for a password and verification. Once completed, you'll have a new volume on your desktop and in the "Computer" view where you can begin dropping files!
To create a compressed, read-only image, you can do one of two things:
Follow the same steps above, however instead of New > Blank Disk Image..., choose New > Disk Image From Folder.... This will first ask you to select a folder full of files. From there, it will present a similar dialog to the one above, but will not prompt for a volume name or size; it will use the name of the folder and the size will be automatically calculated. Be sure to choose to make a compressed image and don't forget the encryption
Alternatively, if you have created a blank image and filled it with files, you can convert that image to a compressed image. This is a handy way to back up your encrypted files. Keep the master read/write uncompressed image as your day-to-day workspace, and periodically convert it to a read-only compressed image which you can back up to an external device. To do this, choose Images > Convert... within Disk Utility. Select the DMG file, and then you'll see the same screen as above.
Protip: if you drag and drop a folder onto Disk Utility's dock icon it will automatically offer to create a disk image out of that folder.
Protip #2: If you create an encrypted disk image out of an unencrypted folder and you want to delete the original, unencrypted files, remember to use secure erase otherwise you risk leaving confidential information on your hard drive.